Question

Financial Learning Systems has 2.34 million shares of common stock outstanding and 126,779 shares of preferred stock. ? (The preferred pays annual cash dividends of ?$5.24 a? share, and the common pays annual cash dividends of 21 cents a? share.) Last? year, the company generated net profit? (after taxes) of $6,869,423.??The? company's balance sheet shows total assets of ?$71 ?million, total liabilities of??$26 ?million, and $5 million in preferred stock. The? firm's common stock is currently trading in the market at ?$39.31 a share.

a.??Given the preceding? information, find the? EPS, P/E? ratio, and book value per share.

b.??What will happen to the price of the stock if EPS rises to ?$4.04 and the? P/E ratio stays where it? is? What will happen if EPS drops to ?$1.69 and the? P/E doesn't? change?

c.??What will happen to the price of the stock if EPS rise to ?$4.04 and the? P/E jumps to 21.3 times? earnings?

d.??What will happen if both EPS and the? P/E ratio drop—to ?$1.69 and 8.9 times? earnings, respectively?

e.??Comment on the effect that EPS and the? P/E ratio have on the market price of the stock.

Answer 1

a.Calculation of EPS:

Profits after tax = 6869423

Less: Preference Dividend 126779*5.24 = 664322

Earnings for Equity = 6205101

No. Of Common Shares 2340,000

EPS = 2.65

P/E Ratio = MPS/EPS = 39.31/2.65 = 14.8 Times

Book Value = (71000000-26000000-5000000)/2340000 $17.09

b.Revised EPE = 4.04 PE 14.8 Times

MPS = 4.04*14.8 = $59.792

If EPS drops to $1.69

Revised MPS = 1.69*14.8 = $25.012

c. MPS = 4.04*21.3 = $86.052

d.MPS = 1.69*8.9 = $15.041

e.MPS is the product of EPS and P/E Ratio. MPS has direct relation with both of them. Higher EPS and Higher P/E Ratio leads to higher MPS and Vice-Versa