You have found the following historical information for Muti-National United (MNU):
|Year1||Year 2||Year 3||Year 4|
|Stock price||$51.45||$ 60.72||$ 69.94||$ 63.50|
Earnings are expected to grow at 14 percent for the next year. Using the company's historical average PE
as the benchmark, what is the target stock price in one year?
The price-earnings ratio (P/E ratio) is the ratio of a firm's earnings per share to the price per share. P/E ratio could be used to detect mis-valuation of stocks. Since P/E ratio is considered industry-specific rather than firm-specific, systematic deviation from benchmark P/E ratio indicates potential mis-valuation.
Answer and Explanation:
Target price next year is$77.23.
We first compute the P/E ratio for each of the past four years, using the formula: P/E ratio = price per share / earnings per share
- year 1: 51.45 / 2.66 = 19.34
- year 2: 60.72 / 2.78 = 21.84
- year 3: 69.94 / 3.06 = 22.86
- year 4: 63.5 / 3.24 = 19.60
The average P/E ratio = (19.34 + 21.84 + 22.86 + 19.60) / 4 = 20.91. To find the target price next year, we first compute the earnings per share next year, given a 14% growth rate, which is:
- 3.24 * (1 + 14%) = 3.6936
The target price next year = earnings next year * benchmark P/E ratio = 3.6936 * 20.91 = $77.23.
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Learn more about this topic:
from Accounting 201: Intermediate Accounting IChapter 13 / Lesson 5