What percentage reduction in the share price will occur by the end of next year if the interest rate increase and the P/E movement both occur?

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 trade at $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 increase next year to 6% and it’s Price/Earnings (P/E) ratio to move to 9.5 times by the end of next year.

What percentage reduction in the share price will occur by the end of next year if the interest rate increase and the P/E movement both occur?
A . Reduction of 7%
B . Reduction of 5%
C . Reduction of 1%
D . Reduction of 0%

View Answer

Answer: A