Question

1.) A company has revenues of $40 MM on an annual basis, with a 35% operating margin, interest expense of $1.0 MM, and a tax rate of 35%. In addition to common stock outstanding of 1.0 MM shares @ $10 par, with a market price of $50, and some debt as part of its capital structure, it has preferred stock issues along the following terms: Com Pref stock, Series A 5%, $25 par value; 1.0 MM shares authorized, 300 M outstanding

Calculate: a.) EPS, b.) P/E

Furthermore, if the sector P/E is 17, ceteris paribus*, how would you feel about the stock? Feel good!

Answer 1

Answer 1(a):

Operating Income = Sales * operating margin = 40 * 35% = $14 MM

Net Income = (Operating Income - Interest) * (1 - Tax rate) = (14 - 1) *(1 - 35%) = $8.45 MM

outstanding preference share = 300M = 0.3 MM

Preference dividend = (5% * 25) * 0.300 = $0.375 MM

EPS = (Net Income - Preference dividend) /  common stock outstanding

= (8.45 - 0.375) / 1

= $8.075

EPS = $8.075

Answer 1(b):

P/E ratio = Share price / EPS = 50 / 8.075 = 6.19

If sector P/E ratio 17, the company's P/E ratio is lower at 6.19. There is potential for the company's share price to increase.