Chapter 2: 18BP (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

Step by step solution

Earning per share for 20X1

$E a r n i n g s p e r s h a r e = \frac{E a r n i n g s a f t e r t a x}{N o o f o u t s \tan d i n g s h a r e s} = \frac{$ 370, 000}{200, 000} = $ 1.85$

Calculation of P/E ratio

$P / E R a t i o = \frac{S t o c k p r i c e}{E a r n i n g p e r s h a r e} = \frac{$ 31.50}{$ 1.85} = 17.03$

Earning per share for 20X2

$E a r n i n g s p e r s h a r e = \frac{E a r n i n g s a f t e r t a x}{N o o f o u t s \tan d i n g s h a r e s} = \frac{$ 436, 000}{200, 000} = $ 2.18$

Calculation of P/E ratio

$P / E R a t i o = \frac{S t o c k p r i c e}{E a r n i n g p e r s h a r e} = \frac{$ 42}{$ 2.18} = 19.27$

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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Retained earning	Bond payable
Accounts payable	Accrued wages payable
Prepaid expenses	Accounts receivable
Plant and equipment	Capital in excess of par
Inventory	Preferred stock
Common stock	Marketable security

	20X1	20X2
Sales	\(8,000,000	\)10,000,000
Cost of goods sold	6,000,000	9,000,000
Inventory	800,000	1,000,000

Short Answer

Step by step solution

Earning per share for 20X1

Calculation of P/E ratio

Earning per share for 20X2

Calculation of P/E ratio

Explanation for the increase in the P/E ratio

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