PacknCamp Corporation has a price of $40, has issued 2 million shares, has increased its cumulated retained earnings by $2 million, and has a dividend yield of 2 percent. What is the price/earnings ratio of PacknCamp?

Question

Quizplus · Accepted Answer

The price/earnings (P/E) ratio is calculated by dividing the market value per share by the earnings per share (EPS). Here, the market value per share is $40. To find the EPS, we need the total earnings, which can be derived from the dividend yield. A 2% dividend yield on a $40 share price implies a $0.80 per share dividend. Since the company has 2 million shares, the total dividends paid are $1.6 million. With an increase in retained earnings of $2 million, the total earnings are $3.6 million ($2 million + $1.6 million). The EPS is then $3.6 million / 2 million shares = $1.8. The P/E ratio is $40 / $1.8 = 22.22, which rounds to 20 for the purpose of the options provided. The historical average P/E ratio for the market has varied over time, but a P/E of 20 can be considered high in many contexts, indicating that the company's stock might be overvalued or that investors expect high growth rates in the future.

PacknCamp Corporation Has a Price of $40, Has Issued 2