Question

Consider Pacific Energy Company and U.S. Bluechips, Inc., both of which reported earnings of $966,000. Without new projects, both firms will continue to generate earnings of $966,000 in perpetuity. Assume that all earnings are paid as dividends and that both firms require a return of 12 percent.

a.
What is the current PE ratio for each company?
b.
Pacific Energy Company has a new project that will generate additional earnings of $116,000 each year in perpetuity. Calculate the new PE ratio of the company.
c.
U.S. Bluechips has a new project that will increase earnings by $216,000 in perpetuity. Calculate the new PE ratio of the firm

Answer 1

a. 8.333

b. 9.334

c. 10.196

Step-by-step explanation:

a. To find price = earnings

R

price = 966,000

.12

price = $8,050,000

P/E ratio = price

earnings

P/E ratio = 8,050,000

966,000

P/E ratio = 8.3333

b. Price = new earnings + current earnings

R

Price = 116,000 + 966,000

.12

Price = 9,016,666.6666

P/E ratio = New Price

initial earnings

P/E ratio = 9,016,666.6666

966,000

P/E ratio = 9.334

c. Price = new earnings + current earnings

R

Price = 216,000 + 966,000

.12

Price = 9,850,000

P/E ratio = New Price

initial earnings

P/E ratio = 9,850,000

966,000

P/E ratio = 10.196