Question

Ratios are mostly calculated based on the financial statements of a firm. However, another group of ratios, called market-based ratios, relate to a firm’s observable market value, stock prices, and book values, integrating information from both the market and the firm’s financial statements.

Consider the case of Blue Dog Manufacturing Corp.:

Blue Dog Manufacturing Corp. just reported a net income of $12,000,000, and its current stock price is $23.00 per share. Blue Dog is forecasting an increase of 25% for its net income next year, but it also expects it will have to issue 1,900,000 new shares of stock (raising its shares outstanding from 5,500,000 shares to 7,400,000 shares).

If Blue Dog’s forecast turns out to be correct and its price-to-earnings (P/E) ratio does not change, what does management expect its stock price to be one year from now? (Hint: If you choose to compute the firm’s price/earnings ratio, round its value to four decimal places.)

a) $21.42 per share

b) $23.00 per share

c) $16.07 per share

d) $26.78 per share

.One year later, Blue Dog Manufacturing Corp.’s stock is trading at $39.75, and the company reports its common equity value as $31,701,600. What is Blue Dog Manufacturing Corp.’s market-to-book(M/B) ratio? (1.07x/22.27x/13.93x/9.29x) choose one

Can a company’s stock have a negative P/E ratio? yes/no (choose one)

Answer 1

Q. 1). Answer :- Option a). $ 21.42 per share.

Explanation :- i). Before forecasting of increase in net income :-

Earnings per share (EPS) = Net income / Number of shares.

= 12000000 / 5500000

= 2.18

Market price per share (MPS) = $ 23.

P/E ratio = MPS / EPS

= 23 / 2.18

= 10.55

ii). After forecasting of increase in net income :-

Revised net income = 12000000 + 25 % of 12000000 = $ 15000000.

Number of shares = 7400000 (Given in the question)

New Earnings per share (EPS) = Net income / Number of shares.

= 15000000 / 7400000

= 2.03

P/E ratio = 10.55 (remain same as before)

Accordingly, Expected market price per share = New EPS * P/E ratio.

= 2.03 * 10.55

= $ 21.42 (approx).

Q. 2). Answer :- Option D) . 9.29x

Explanation :- Book value per share = Common equity value / Number of shares.

= 31701600 / 7400000

= 4.28 (approx)

Market to book ratio (M/B ratio) = Market price per share / Book value per share.

= 39.75 / 4.28

= 9.29x (Option D).

Q. 3). Yes, The company can have negative P/E ratio if the net income of company is in minus i.e., if the company suffers from loss then the EPS will be negative, consequently, P/E ratio will also be negative.