Question

Lane Inc. just reported net income of $2,800,000, and its current stock price is $33 per share. Lane is forecasting $4,000,000 in net income next year, but it also expects it will have to issue 500,000 new shares of stock (raising its shares outstanding from 1,500,000 to 2,000,000). If Lane's forecast turns out to be right, and its price/earnings (P/E) ratio does not change, what does Lane expect its stock price to be one year from now?

Answer 1

Price per share Year 1= $35.36

Step-by-step explanation:

The P/E ratio or the price earnings ratio is an indicator that calculates the dollar amount that an investor is willing to invest in a company for each 1 dollar of that company's earnings. It is calculated as follows,

P/E = Price per share / Earnings per share

The first thing we do is to determine the earnings per share today.

Earnings per share = Net Income / No. of shares outstanding

Earnings per share = 2800000 / 1500000

Earnings per share = $1.867

We need to determine the P/E ratio today which is expected to remain the same for next year also.

P/E ratio = 33 / 1.867

P/E Ratio = 17.675 rounded off to 17.68

The earnings next year will be,

Earnings per share year 1 = 4000000 / 2000000

Earnings per share Year 1 = $2

Taking the constant P/E and year 1's earnings per share, we calculate the price in year 1 to be,

17.68 = Price per share / 2

17.68 * 2 = Price per share

Price per share Year 1= $35.36