Question

Consider Pacific Energy Company and U.S. Bluechips, Inc., both of which reported earnings of $952,000. Without new projects, both firms will continue to generate earnings of $952,000 in perpetuity. Assume that all earnings are paid as dividends and that both firms require a return of 12 percent.

What is the current PE ratio for each company?

Answer 1

PE ratio for each company = 8.33

Step-by-step explanation:

Using the zero growth model, total value of each company's shares =
`(Dividend)/(required return)` =
`(952,000)/(0.12)` = 7,933,333.33

The PE ratio for each firm =
`(Total Price of Shares)/(Total Earnings)` =
`(7,933,333.33)/(952,000)` = 8.33

This means that for every dollar of earnings, investors are willing to $8.33 for each firm.