The stock of East/West Maps is currently selling for $122.40, which equates to a

Question

The stock of East/West Maps is currently selling for $122.40, which equates to a P/E ration of 30x.

a. Using the P/E ration, compute the current EPS of East/West.

b. Assume that earnings next year increase by 20 percent, but the P/E ration drops to 25x, which is more in line with the industry average. What will be the price of East/West's stock next year?

c. If an investor purchases the stock today for $122.40 and sells it in one year at the price computed in part (b), what rate of return would be earned.

Explanation / Answer

Part A

P/E ratio = Price per share / Earnings per share

30 = $122.40 / EPS

30EPS = $122.40

EPS = $122.40 / 30

EPS = $4.08 per share (Answer)

Part B

With increase in total earnings, EPS will also increase next year.

Next year EPS = $4.08 x 120% = $4.896 per share

Next year's P/E Ratio = 25 times

As already discussed, P/E Ratio = Price per share / EPS

25 = P / 4.896

P = $4.896 x 25

P = $122.40 per share (Answer)

Part C

Rate of return = (Appreciation in stock price / Cost of purchase) x 100

= (($122.40 - $122.40) / $122.40) x 100

= ($0 / $122.40) x 100

= 0% (Answer)

Note: If the EPS in PART B is rounded off from 4.896 to 4.90, the price will be $122.50

Answer is PART C will change accordingly then and rate of return will be 0.0817%

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