The balance sheet for Larry Underwood Motors shows a book value of stockholders’ equity (book value per share total shares outstanding) of $1,349,000. Furthermore, the firm’s income statement for th ended has a net income of $556, 000, which is $0.285 per share of common stock outstanding. The price-earnings ratio for firms similar to Underwood Motors is 1871
What price would you expect Underwood Motors shares to sell for? b. What is the book value per share for Underwood’s shares? Help me solve this a. What price would you expect Underwood Motors shares to sell for? The market price per share is $(Round to the nearest cent)
The Correct Answer and Explanation is :
To solve the problem:
Step 1: Understand the given data
- Book value of stockholders’ equity: $1,349,000
- Net income: $556,000
- Net income per share: $0.285
- Price-Earnings (P/E) ratio: 18.71
We need to calculate:
- The expected market price per share (using the P/E ratio and earnings per share).
- The book value per share (using total equity and the number of shares).
Part (a): Expected Market Price Per Share
The formula for market price per share is:
[
\text{Market Price Per Share} = \text{Earnings Per Share (EPS)} \times \text{P/E Ratio}
]
Given:
[
\text{EPS} = 0.285, \quad \text{P/E Ratio} = 18.71
]
[
\text{Market Price Per Share} = 0.285 \times 18.71 = 5.33235
]
Rounded to the nearest cent:
[
\text{Market Price Per Share} = 5.33
]
Part (b): Book Value Per Share
The formula for book value per share is:
[
\text{Book Value Per Share} = \frac{\text{Book Value of Equity}}{\text{Number of Shares Outstanding}}
]
To find the number of shares outstanding:
[
\text{Number of Shares Outstanding} = \frac{\text{Net Income}}{\text{EPS}} = \frac{556,000}{0.285} = 1,950,877.19
]
Now calculate the book value per share:
[
\text{Book Value Per Share} = \frac{1,349,000}{1,950,877.19} = 0.6914
]
Rounded to the nearest cent:
[
\text{Book Value Per Share} = 0.69
]
Final Answer:
- Expected Market Price Per Share: $5.33
- Book Value Per Share: $0.69
Explanation:
The market price per share reflects the value investors assign based on the company’s earnings potential, captured through the P/E ratio. Multiplying EPS by the P/E ratio gives an estimate of the market price, which is $5.33 per share.
The book value per share shows the equity value per share based on accounting records. By dividing total equity by the number of shares, we find this value is $0.69 per share. The difference between market price and book value highlights how market expectations can drive valuation above the book value.