Chapter 2: 19BP (page 51)

Stilley Corporation had earnings after taxes of $436,000 in 20X2 with 200,000 shares outstanding. The stock price was $42.00. In 20X3, earnings after taxes declined to $206,000 with the same 200,000 shares outstanding. The stock price declined to $27.80.
a. Compute earnings per share and the P/E ratio for 20X2.
b. Compute earnings per share and the P/E ratio for 20X3.
c. Give a general explanation of why the P/E changed. You might want to
consult the text to explain this surprising result.

Short Answer

Expert verified

(a) For the year 20X2,

Earnings per share: $2.18

P/E ratio: 19.27

(b) For the year 20X3,

Earnings per share: $1.03

P/E ratio: 27

(c) The increase in the P/E ratio is due to a decrease in the stock price per share and earnings per share of the company.

Step by step solution

Earnings 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$

Earnings per share for 20X3

$E a r n i n g s p e r s h a r e = \frac{E a r n i n g s a f t e r t a x}{N o o f o u t s \tan d i n g s h a r e s} = \frac{$ 206, 000}{200, 000} = $ 1.03$

Calculation of P/E ratio

$P / E R a t i o = \frac{S t o c k p r i c e}{E a r n i n g p e r s h a r e} = \frac{$ 27.80}{$ 1.03} = 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 earnings per share. Hence, the changes in the P/E ratio are caused by the changes in the market price per share from $42 to $27.80 and the earnings per share from $2.18 to $1.03 of the company.

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Times mirror and glass company
Sales	\)126,000
Less: Cost of goods sold	93,000
Gross profit	\(33,000
Less: selling and administrative expenses	11,000
Lease Expenses	4,000
Operating profit*	\)18,000
Less: Interest expenses	3,000
Earning before taxes	\(15,000
Less: Taxes (30%)	4,500
Earning after taxes	\)10,500

Stud Clothier
Balance sheet 20X1
Assets		Liabilities and Equity
Cash	\)60,000	Account payable	\(220,000
Account receivable	240,000	Accrued taxes	30,000
Inventory	350,000	Bonds payable (long term)	150,000
Plant and equipment	410,000	Common stock	80,000
		Paid in capital	200,000
		Retained earnings	380,000
Total assets	\)1,060,000	Total LIbilities and Equity	$1,060,000

Short Answer

Step by step solution

Earnings per share for 20X2

Calculation of P/E ratio

Earnings per share for 20X3

Calculation of P/E ratio

Explanation for the increase in the P/E ratio

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