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(i) A P/E ratio is the ratio of the market value of a share to earnings per share: it is often
described as the number of years earnings required before an investor recovers the
purchase price of a share (on the assumption that annual earnings are constant). The
earnings of a company with a high P/E ratio are therefore valued more by investors
because they are prepared to wait more years to recover their investment. A high P/E
ratio therefore tends to indicate that a company is somehow „more secure?. Thus:
A well-established company is likely to have a higher P/E ratio than a company
which is newly-quoted on the stock exchange;
A large company with a bigger asset backing is likely to have a higher P/E ratio than
a small company with smaller asset base – because assets are regarded as a last resort
security in the event of a winding up;
A company may suffer a temporary fall in profits and if investors expect profits to
recover, they may be prepared to pay more for a share than current performance
would justify - i.e. the P/E ratio may be temporary high;
Investors may expect a company to grow considerably in the next few years, and in
anticipation of growth, will pay a higher price for shares now. A company with
growth prospects should therefore have a higher P/E ratio than companies where no
growth is expected.
Dividend policy affects share prices as much, if not more, than earnings retention
rate may therefore have a higher P/E ratio than a company with the same volume of
earnings but which pays a lower dividend. Dividend cover may therefore influence
the P/E ratio.
marto answered the question on February 11, 2019 at 11:18
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2. Variable cost per unit of product – Sh.850
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Swaleh Ltd. has been in operation for the last eight years. The company is all equity
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the industry of 6.00. The company has been consistent in paying a dividend of Sh.1.25
per share during the last five years of its operations, and indications are that the current
level of operating income can be maintained in the foreseeable future. Tax has been at a
rate of 30%.
The management of Swaleh Ltd. is contemplating the implementation of a new project
which requires Sh.10 million. Since no internal sources of funds are available,
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Alternative A
To raise the Sh.10 million through a rights issue. Management is of the opinion that a
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Alternative B
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Irrespective of the alternative selected in financing the new project, corporation tax is
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(ii) If Alternative A is selected, determine the number of shares in the rights issue
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Magma Ltd. wishes to make a choice between two mutually exclusive projects. Each of
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Project A
This project is made up of two sub-projects. The first sub-project will require an initial
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Project B
This project will generate Sh.87,000,000 per annum in
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Date posted: February 11, 2019. Answers (1)