Question

Ratios are mostly calculated using data drawn from the financial statements of a firm. However, another group of ratios, called market value ratios, relate to a firm’s observable market value, stock prices, and book values, integrating information from both the market and the firm’s financial statements.

Consider the case of Cold Goose Metal Works Inc.:

Cold Goose Metal Works Inc. just reported earnings after tax (also called net income) of $9,000,000 and a current stock price of $34.00 per share. The company is forecasting an increase of 25% for its after-tax income next year, but it also expects it will have to issue 2,500,000 new shares of stock (raising its shares outstanding from 5,500,000 to 8,000,000).

If Cold Goose’s forecast turns out to be correct and its price/earnings (P/E) ratio does not change, what does the company’s management expect its stock price to be one year from now? (Round any P/E ratio calculation to four decimal places.)

$29.23 per share

$34.00 per share

$21.92 per share

$36.54 per share

One year later, Cold Goose’s shares are trading at $48.36 per share, and the company reports the value of its total common equity as $46,768,000. Given this information, Cold Goose’s market-to-book (M/B) ratio is   .

Can a company’s shares exhibit a negative P/E ratio?

No

Yes

Which of the following statements is true about market value ratios?

Low P/E ratios could mean that the company has a great deal of uncertainty in its future earnings.

High P/E ratios could mean that the company has a great deal of uncertainty in its future earnings.

Answer 1

1. Current year PE ratio=Price of the Share/Earnings per share=$34/(9,000,000/5,500,000)=20.78

Next year Earnings=9,000,000*(1+25%)=$11,250,000

Next year Earnings per share=11,250,000/8,000,000=1.406

The Sahre price should be at=PE*EPS=20.78*1.406=29.23

Option A is correct

2. Market to Book Value ratio=(Market share price/Book value per share)

Book value per share=Common Equity value/Total number of sahres=46,768,000/8,000,000=5.85

Market to Book Value ratio=$48.36/$5.85=8.27

3. Yes, There is a possibility that negative PE exists. It says that the company is making negative earnings.

4. The statement of Low P/E ratios could mean that the company has a great deal of uncertainty in its future earnings is correct

Low P/E means Investors that unceratin about the future earnings and thats the reason investors will not show much interest to invest in the company's stock.