Question

Botox Facial Care had earnings after taxes of $370,000 in 20X1 with 200,000 shares of stock outstanding. The stock price was $31.50. In 20X2, earnings after taxes increased to $436,000 with the same 200,000 shares outstanding. The stock price was $42.00.

a. Compute earnings per share and the P/E ratio for 20X1. The P/E ratio equals the stock price divided by earnings per share.
b. Compute earnings per share and the P/E ratio for 20X2.
c. Give a general explanation of why the P/E ratio changed.

Answer 1

The EPS for 20X1 is $1.85 with a P/E ratio of 17.03, and for 20X2, the EPS is $2.18 with a P/E ratio of 19.27. The change in the P/E ratio generally indicates the change in investor expectations about a company's future earnings and profitability.

Step-by-step explanation:

To compute the earnings per share (EPS) and the price-to-earnings (P/E) ratio for Botox Facial Care in 20X1, you would need to divide the company's earnings after taxes by the number of shares outstanding. For 20X1, with earnings of $370,000 and 200,000 shares outstanding, the EPS would be $1.85 ($370,000 / 200,000 shares). The P/E ratio is calculated by dividing the stock price by the EPS. So, for 20X1, it would be 17.03 ($31.50 / $1.85).

For 20X2, the EPS calculation would be similar: $436,000 in earnings divided by 200,000 shares outstanding gives us an EPS of $2.18. The P/E ratio for 20X2 would then be 19.27 ($42.00 / $2.18).

The P/E ratio's change generally reflects investor expectations about future growth or profitability. An increase in the P/E ratio might suggest that investors are expecting higher earnings growth in the future or have a better perception of the company's future prospects. Therefore, an increasing P/E ratio, as seen from 20X1 to 20X2 in this case, indicates an improved investor sentiment regarding the company's future performance.