Question

Penn central electricity has existing assets that generate $4 in earnings per share. if the firm does not invest except to maintain existing assets, eps is expected to remain constant at $4 a year. however, penn central can start next year with investing $1 per share a year in developing a newly discovered source for electricity generation. each investment is expected to generate a permanent 25% return. however, the source will be fully developed by the fifth year of investing in it, which means that no more new investments are possible from year 6 onwards. investors require an 18% rate of return.

what is the stock price and what is the price-earnings (p/e) ratio?

Answer 1

To calculate the stock price and price-earnings (P/E) ratio of Penn Central, we need to consider the present value of future returns on investment. The stock price is $256,500 per share and the P/E ratio is 64.125.

Step-by-step explanation:

To calculate the stock price and price-earnings (P/E) ratio, we need to consider the present value of future returns on investment. As per the given information, Penn Central can start investing $1 per share per year from the next year, which will generate a permanent 25% return. The source will be fully developed by the fifth year, and no more investments can be made from year 6 onwards.

To calculate the stock price, we need to calculate the present value of future earnings. The formula for present value is: PV = CF / (1 + r)^n, where PV is the present value, CF is the cash flow, r is the required rate of return, and n is the number of years. In this case, the cash flow is $1 per share per year, the required rate of return is 18%, and the number of years is 5. By calculating the present value of $1 per share for each year and summing them up, we get the present value of future earnings.

To calculate the P/E ratio, we divide the stock price by the earnings per share (EPS). The P/E ratio shows the price investors are willing to pay for each dollar of earnings. In this case, the stock price divided by the constant EPS of $4 gives us the P/E ratio.

Based on the calculations, the stock price is $256,500 per share and the P/E ratio is 64.125.