Consider Pacific Energy Company and Atlantic Energy, Incorporated, both of which reported earnings of $790,000. Without new projects, both firms will continue to generate earnings of $790,000 in perpetuity. Assume that all earnings are paid as dividends and that both firms require a return of 11 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 $175,000 each year in perpetuity. Calculate the new PE ratio of the company. c. Atlantic Energy has a new project that will increase earnings by $350,000 in perpetuity. Calculate the new PE ratio of the firm.
Financial Ratios
A Ratio refers to a figure calculated as a reference to the relationship of two or more numbers and can be expressed as a fraction, proportion, percentage, or the number of times. When the number is determined by taking two accounting numbers derived from the financial statements, it is termed as the accounting ratio.
Return on Equity
The Return on Equity (RoE) is a measure of the profitability of a business concerning the funds by its stockholders/shareholders. ROE is a metric used generally to determine how well the company utilizes its funds provided by the equity shareholders.
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Consider Pacific Energy Company and Atlantic Energy, Incorporated, both of which reported earnings of $790,000. Without new projects, both firms will continue to generate earnings of $790,000 in perpetuity. Assume that all earnings are paid as dividends and that both firms require a return of 11 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 $175,000 each year in perpetuity. Calculate the new PE ratio of the company. |
| c. |
Atlantic Energy has a new project that will increase earnings by $350,000 in perpetuity. Calculate the new PE ratio of the firm. |
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