Consider Pacific Energy Company and U.S. Blue chips, Inc., both of which reported earnings of $750,000. Without new projects, both firms will continue to generate earnings of $750,000 in perpetuity. Assume that all earnings are paid as dividends and that both firms require a 14 percent rate of return.
a. What is the current PE ratio for each company?
b. Pacific Energy Company has a new project that will generate additional earnings of $100,000 each year in perpetuity. Calculate the new PE ratio of the company.
c. U.S. Bluechips has a new project that will increase earnings by $200,000 in perpetuity. Calculate the new PE ratio of the firm.
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