Question

Botox Facial Care had earnings after taxes of $298,000 in 20X1 with 200,000 shares of stock outstanding. The stock price was $58.80. In 20X2, earnings after taxes increased to $330,000 with the same 200,000 shares outstanding. The stock price was $70.00.

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.) (Do not round intermediate calculations. Round your final answers to 2 decimal places.)

b. Compute earnings per share and the P/E ratio for 20X2. (Do not round intermediate calculations. Round your final answers to 2 decimal places.)
  
c. Why did the P/E ratio change? (Do not round intemediate calculations. Input your answers as percents rounded to 2 decimal places.)

Answer 1

a.

P/E ratio for 20X1 = Market value of total equity / Earnings after tax

= (200,000 × $58.80) / $298,000

= $11,760,000 / $298,000

= 39.46

P/E ratio for 20X1 is 39.46.

b.

P/E ratio for 20X2 = Market value of total equity / Earnings after tax

= (200,000 × $70.00) / $330,000

= $14,000,000 / $330,000

= 42.42

P/E ratio for 20X2 is 42.42.

c.

PE ratio is defined as dollar value investor wants to invest in company for one dolar of earnings. in 20X1 investor wants toinvest $39.46 per dollar of earnings but in 20x2 investor confidence about company performance increase and so they wants to invest $42.42 forone dollar of earnings.

PE ratio change because investor becomemore optimistic about company performace.