Chapter 2: Q19BP (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

$\begin{array}{rcl} Earnings per share & = & \frac{Earnings after tax}{No of outstanding shares} \\ = & \frac{$ 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}$

Earnings per share for 20X3

$\begin{array}{rcl} Earnings per share & = & \frac{Earnings after tax}{No of outstanding shares} \\ = & \frac{$ 206, 000}{200, 000} \\ = & $ 1.03 \end{array}$

Calculation of P/E ratio

$\begin{array}{rcl} P / E Ratio & = & \frac{Stock price}{Earning per share} \\ = & \frac{$ 27.80}{$ 1.03} \\ = & 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 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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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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