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Chapter 2: Q18BP (page 51)

Botox Facial Care had earnings after taxes of \(370,000 in 20X1 with 200,000 shares of stock outstanding. The stock price was \)31.50. In 20X2, earnings after taxes increased to \(436,000 with the same 200,000 shares outstanding. The stock price was \)42.00

a. Compute earnings per share and the P/E ratio for 20X1. The P/E ratio

equals the stock price divided by earnings per share.

b. Compute earnings per share and the P/E ratio for 20X2.

c. Give a general explanation of why the P/E ratio changed.

Short Answer

Expert verified

(a) For the year 20X1,

Earning per share: $1.85

P/E ratio: 17.03

(b) For the year 20X2,

Earning per share: $2.18

P/E ratio: 19.27

(c) The increase in the P/E ratio is due to the increase in the stock price of the share.

Step by step solution

01

Earning per share for 20X1

Earningspershare=EarningsaftertaxNoofoutstandingshares=$370,000200,000=$1.85

02

Calculation of P/E ratio

P/ERatio=StockpriceEarningpershare=$31.50$1.85=17.03

03

Earning per share for 20X2

Earningspershare=EarningsaftertaxNoofoutstandingshares=$436,000200,000=$2.18

04

Calculation of P/E ratio

P/ERatio=StockpriceEarningpershare=$42$2.18=19.27

05

Explanation for the increase in the P/E ratio

The P/E ratio is computed by dividing the market price of the share by the earning per share. Hence, when the market price of the share goes up, the P/E ratio also increases.

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Most popular questions from this chapter

Billy鈥檚 Crystal Stores Inc. has assets of $5,960,000 and turns over its assets 1.9 times per year. Return on assets is 8 percent. What is the firm鈥檚 profit margin (return on sales)?

Comment on why inflation may restrict the usefulness of the balance sheet as normally presented.

Martin Electronics has an accounts receivable turnover equal to 15 times. If accounts receivable are equal to $80,000, what is the value for average daily credit sales?

Precision Systems had sales of \(820,000, cost of goods of \)510,000, selling and administrative expense of \(60,000, and operating profit of \)103,000. What was the value of depreciation expense? Set this problem up as a partial income statement and determine depreciation expense as the 鈥減lug鈥� figure required to obtain the operating profit.

For December 31, 20X1, the balance sheet of Baxter Corporation was as follows:

Current assets

Liabilities

Cash

\(15,000

Accounts payable

\)17,000

Accounts receivable

20,000

Notes payable

25,000

Inventory

30,000

Bonds payable

55,000

Prepaid expenses

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Sales for 20X2 were \)245,000, and the cost of goods sold was 60 percent of sales. Selling and administrative expense was \(24,500. Depreciation expense was 8 percent of plant and equipment (gross) at the beginning of the year. Interest expense for the notes payable was 10 percent, while the interest rate on the bonds payable was 12 percent. This interest expense is based on December 31, 20X1 balances. The tax rate averaged 20 percent.

\)2,500 in preferred stock dividends were paid, and \(5,500 in dividends were paid to common stockholders. There were 10,000 shares of common stock outstanding.

During 20X2, the cash balance and prepaid expenses balances were

unchanged. Accounts receivable and inventory increased by 10 percent. A new machine was purchased on December 31, 20X2, at a cost of \)40,000. Accounts payable increased by 20 percent. Notes payable increased by \(6,500 and bonds payable decreased by \)12,500, both at the end of the year. The preferred stock, common stock, and paid-in capital in excess of par accounts did not change.

b. Prepare a statement of retained earnings for 20X2.
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