The Charleston Company is a relatively small, privately owned firm. Last year the company had after-tax income of $15,000, and 10,000 shares were outstanding. The owners were trying to determine the equilibrium market value for the stock, prior to taking the company public. A similar firm which is publicly traded had a price/earnings ratio of 5.0. Using only the information given, estimate the market value of one share of Charleston's stock.
A) $10.00
B) $ 7.50
C) $ 5.00
D) $ 2.50
E) $ 1.50

Question

Quizplus · Accepted Answer

To estimate the market value of one share of Charleston's stock, we need to use the price/earnings ratio of the similar publicly traded firm. 
Price/Earnings ratio = Market Price per share / Earnings per share
Therefore, Market Price per share = Price/Earnings ratio * Earnings per share
Earnings per share = After-tax income / Number of shares outstanding = $15,000 / 10,000 = $1.50
Market Price per share = 5.0 * $1.50 = $7.50
Therefore, the market value of one share of Charleston's stock would be $7.50.

The Charleston Company Is a Relatively Small, Privately Owned Firm