Question

Consider Pacific Energy Company and U.S. Bluechips, Inc., both of which reported earnings of $952,000. Without new projects, both firms will continue to generate earnings of $952,000 in perpetuity. Assume that all earnings are paid as dividends and that both firms require a return of 12 percent.

What is the current PE ratio for each company?

Answer 1

Answer:

PE ratio for each company = 8.33

Explanation:

Using the zero growth model, total value of each company's shares = $\frac{Dividend}{required return}$ = $\frac{952,000}{0.12}$ = 7,933,333.33

The PE ratio for each firm = $\frac{Total Price of Shares}{Total Earnings}$ = $\frac{7,933,333.33}{952,000}$ = 8.33

This means that for every dollar of earnings,  investors are willing to $8.33 for each firm.