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

Step by step solution

Earning per share for 20X1

$\begin{array}{rcl} Earnings per share & = & \frac{Earnings after tax}{No of outstanding shares} \\ = & \frac{$ 370, 000}{200, 000} \\ = & $ 1.85 \end{array}$

Calculation of P/E ratio

$\begin{array}{rcl} P / E Ratio & = & \frac{Stock price}{Earning per share} \\ = & \frac{$ 31.50}{$ 1.85} \\ = & 17.03 \end{array}$

Earning per share for 20X2

$\begin{array}{rcl} Earnings per share & = & \frac{Earnings after tax}{No of outstanding shares} \\ = & \frac{$ 436, 000}{200, 000} \\ = & $ 2.18 \end{array}$

Calculation of P/E ratio

$\begin{array}{rcl} P / E Ratio & = & \frac{Stock price}{Earning per share} \\ = & \frac{$ 42}{$ 2.18} \\ = & 19.27 \end{array}$

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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Taxes	Earning per share
Share Outstanding	Earning before taxes
Interest Expense	Cost of goods sold
Depreciation Expense	Earning after taxes
Preferred Stcok dividends	Earning available to common stockholders
Sales	Selling and administrative expense
Gross profit

	Capable corporation	Muli-media inc
Net income	\(31,200	\)140,000
Sales	317,000	2,700,000
Total assets	402,000	965,000
Total debts	163,000	542,000
Stockholder’s equity	239,000	423,000

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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