Question

Green Caterpillar Garden Supplies Inc. just reported earnings after tax (also called net income) of $9,250,000 and a current stock price of $12.00 per share. The company is forecasting an increase of 25% for its after-tax income next year, but it also expects it will have to issue 3,000,000 new shares of stock (raising its shares outstanding from 5,500,000 to 8,500,000). If Green Caterpillar’s forecast turns out to be correct and its price/earnings (P/E) ratio does not change, what does the company’s management expect its stock price to be one year from now? (Round any P/E ratio calculation to four decimal places.)

Answer 1

$9.71

Explanation:

The computation of stock price is shown below:-

Current EPS = Net Income ÷ Number of Common Shares Outstanding

= $9,250,000 ÷ 5,500,000

= $1.68

Current P/E ratio = Current stock price ÷ Current EPS

= $12 ÷ $1.68

= 7.14

Next year's EPS = $9,250,000 × 1.25 ÷ 8,500,000

= $1.36

Next year's stock price = $ 1.36 x 7.14

= $9.71