Consider Pacific Energy Company and U.S. Bluechips, Inc., both of which reported
ID: 2816035 • Letter: C
Question
Consider Pacific Energy Company and U.S. Bluechips, Inc., both of which reported earnings of $951,000. Without new projects, both firms will continue to generate earnings of $951,000 in perpetuity. Assume that all earnings are paid as dividends and that both firms require a return of 14 percent. a. What is the current PE ratio for each company? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) PE ratio times b. Pacific Energy Company has a new project that will generate additional earnings of $101,000 each year in perpetuity. Calculate the new PE ratio of the company. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) PE ratio times c. U.S. Bluechips has a new project that will increase earnings by $201,000 each year in perpetuity. Calculate the new PE ratio of the company. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) PE ratio
Explanation / Answer
1) PE ratio = Total present value / Earnings
= ($951,000/0.14) / $951,000
= 6792857.14 / 951000
= 7.14
2) new PE ratio = [($951,000 + $101,000)/0.14] / $951,000
=[1052000 /0.14] / $951,000
=7514285.71 / 951,000
= 7.90
3) new PE ratio = [($951,000 + $201000)/0.14] / $951,000
= (1152000 /0.14) / 951000
= 8228571.43 / 951000
= 8.65
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