Drake owns 100 stocks of balancia, inc. he had bought these stocks at a face value of $10. the market price of these stocks is now $50 each. balancia has declared a dividend of 20% this year. balancia’s retained earnings for the year is $2,000,000 and it has 1,000,000 outstanding stocks. what is the p/e ratio? a. 25 b. 20 c. 10 d. 15

The catch in this question is what do you do with the dividends and the answer is nothing. What they do with their earnings is not part of the PE calculations. All an investor is interested in is the price of the outstanding shares divided by earnings.

Price of 1 share = 50 dollars.

Number of shares = 1 000 000

Price = 50 dollars/ share

Total price of the stock=50 * 1 000 000 = 50 000 000 dollars.

The earnings is 2 000 000

PE = Price divided by earnings = 50 000 000 / 2 000 000 = 25 which is just a touch high. The market can and sometimes does punish companies with a high PE ratio even with a dividend.