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A company's current earnings before interest and taxation are $5 million.
These are expected to remain constant for the forseeable future.
The company has 10 million shares in issue which currently tradeat $3.60.
It also has a $10 million long term floating rate loan.
The current interest rate on this loan is 5%.
The company pays tax at 20%.
The company expects interest rates to increasenext yearto 6% andit's Price/Earnings (P/E) ratioto move to 9.5 times by the end of next year.
What percentagereduction in the share pricewill occurby the end of next year iftheinterest rate increaseand theP/Emovementboth occur?
Suggested Answer: A
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12 comments · newest first
MA
Marica
2 months ago
I’m leaning towards 7%. Higher rates and P/E drop? Ouch!
PA
Paulina
2 months ago
I feel like it's a 5% reduction. The interest hike will hit hard.
MA
Maira
2 months ago
This question is tricky. I think the reduction could be significant.
CA
Carey
3 months ago
Wait, how can they expect constant earnings with rising interest rates?
LO
Loren
3 months ago
Agree, 5% feels more realistic with those numbers.
DO
Donte
3 months ago
Not sure about a 7% drop, seems a bit high.
CL
Clemencia
3 months ago
I think the P/E ratio change will definitely impact the price.
WI
Willetta
3 months ago
Current earnings are $5 million, with 10 million shares.
TR
Truman
3 months ago
I think I saw something similar where the share price didn't change much with a small interest rate increase, so maybe the reduction is minimal?
CA
Carli
4 months ago
I feel like the P/E ratio drop will offset some of the interest rate increase, but I can't recall the exact calculations we did in class.
GA
Gail
4 months ago
This reminds me of a practice question where we had to adjust share prices based on earnings and interest rates. I think the reduction could be significant.
ON
Oneida
4 months ago
I remember calculating the impact of interest rates on earnings, but I'm not sure how to factor in the P/E ratio change.