Question

Lake Inc. and River Inc. reported net incomes of $236,000 and $196,000, respectively, for the most recent fiscal year. Both companies had 40,000 shares of common stock issued and outstanding. The market price per share of Lake’s stock was $55, while River’s sold for $59 per share.

Answer 1

Answer:

These are the questions for the statement:

1) Determine the P/E ratio for each company

2) Based on the P/E ratios computed, which company has greater potential for growth in income.

Explanation:

First we need to calculate the Earnings Per Share for both companies, the formula is:

Earnings Per Share = Net Income / Common shares outstanding

Lake Inc Earnings Per Share = $236,000 / 40,000

                                                = $5.9

River Inc Earnings Per Share = $196,000 / 40,000

                                                = $4.9

Now, we can calcuate the Pric-to Earnings Ratios

Price-To-Earnings Ratio (P/E Ratio) = Market Value Per Share / Earnings Per

Lake Inc P/E Ratio = $55 / $5.9

                               = $9.3

River Inc P/E Ratio = $59 / $4.9

                               = $12.0

The company most likely to grow according to P/E Ratios is River Inc, because its ratio is higher. Investors should choose this company over the other.