FI 491 Lecture Notes - Lecture 35: Price–Earnings Ratio, Investment Banking

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28 Jun 2019

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They play a large part in the increase or decrease in the price of a stock. This is the corporations post-tax earnings, divided by the number of outstanding shares of a common stock. (an increase is earnings is generally good) The price of one stock is divided by the earnings per share of stock over the past 12 months. (this ratio needs to be compared to the industry p/e ratio to have value) Total return / original investment x 1 / n (number of years investment is held) Beta > 1 = stock has more risk than market. Beta is calculated from past relationships to the market and thus changes over time. A market in which an investor purchases financial securities through an investment bank, or other representative, from an issuer of those securities. Financial firm that assists corporations in raising funds, usually by helping to sell new security issues.

Related Questions

Problem 14-21

Yerba Industries is an all-equity firm whose stock has a beta of 1.2 and an expected return of 12.5%. Suppose it issues new risk-free debt with a 5% yield and repurchases 40% of its stock. Assume perfect capital markets.
a. What is the beta of Yerba stock after this transaction?
b. What is the expected return of Yerba stock after this transaction?
Suppose that prior to this transaction, Yerba expected earnings per share this coming year of $1.50, with a forward P/E ratio (that is, the share price divided by the expected earnings for the coming year) of 14.
c. What is Yerbaâs expected earnings per share after this transaction? Does this change benefit shareholders? Explain.
d. What is Yerbaâs forward P/E ratio after this transaction? Does the P/E ratio go up or down?

Unlevered beta 1.20
Expected return 12.50%
Risk-free rate 5.00%
New debt level 40.00%

New Debt/Equity:
Market risk premium:

a. What is the beta of Yerba stock after this transaction?

New beta:

b. What is the expected return of Yerba stock after this transaction?

New expected return on equity:

Suppose that prior to this transaction, Yerba expected earnings per share this coming year of $1.50, with a forward P/E ratio (that is, the share price divided by the expected earnings for the coming year) of 14.
c. What is Yerbaâs expected earnings per share after this transaction? Does this change benefit shareholders? Explain.

Old EPS $1.50
Forward P/E 14
Assumed shares 100

Price per share:
Old equity:
New debt:
New earnings:
New equity:
New shares:
New EPS:

d. What is Yerbaâs forward P/E ratio after this transaction? Does the P/E ratio go up or down?

New P/E:
Price/Earnings ratio:

turquoisejellyfish250

Galles Corporation is evaluating an extra dividend versus a share repurchase. In either case, $14,000 would be spent. Current earnings are $1.60 per share, and the stock currently sells for $56 per share. There are 3,500 shares outstanding. Ignore taxes and other imperfections.

a. Evaluate the two alternatives in terms of the effect on the price per share of the stock and shareholder wealth per share. (Do not round intermediate calculations. Round your answers to 2 decimal places, e.g., 32.16.)

Alternative I

Extra dividend Price per share $ 52
Shareholder wealth $ 56

Alternative II Repurchase

Price per share $
Shareholder wealth $

b. What will the company's EPS and P/E ratio be under the two different scenarios? (Do not round intermediate calculations. Round your final answers to 2 decimal places, e.g., 32.16.) Alternative 1

EPS $
P/E ratio

Alternative II

EPS $
P/E ratio

Stock repurchase The following financial data on the Bond Recording Company are

available:

Earnings available for common stockholders $800,000

Number of shares of common stock outstanding 400,000

Earnings per share ($800,000, 400,000) $2

Market price per share $20

Price/earnings (P/E) ratio ($20, $2) 10

The firm is currently considering whether it should use $400,000 of its earnings to

pay cash dividends of $1 per share or to repurchase stock at $21 per share.

a. Approximately how many shares of stock can the firm repurchase at the $21-pershare

price, using the funds that would have gone to pay the cash dividend?

b. Calculate the EPS after the repurchase. Explain your calculations.

c. If the stock still sells at 10 times earnings, what will the market price be after the

repurchase?

d. Compare the pre- and postrepurchase earnings per share.

e. Compare and contrast the stockholdersâ positions under the dividend and repurchase

alternatives. What are the tax implications under each alternative?

FI 491 Lecture Notes - Lecture 35: Price–Earnings Ratio, Investment Banking

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