"31. If the market value of a share of common stock is 3.3 times book value for 2007, what isthe firm’s P/E ratio for 2008?2-31. Solution:Market value =3.3×$9.42 = $31.09 P/E ratio =market value/earnings per share =$31.09/$1.25 =24.87 S2-41 Comprehensive ProblemCP 2-1. Additional problem not included in the text:The chief financial officer of Morton Industries wasreviewing the income statement of her firm in preparationfor a meeting with the president of the company.The information is shown in Exhibit 1.Morton IndustriesIncome StatementFor the Years Ended December 31, 2007 & 2008 2007 2008Sales $877,200 $923,147Cost of goods sold 343,720 344,160Gross profits 533,480 578,987Selling and administrative expense 81,000 93,237Depreciation Expense 112,000 120,000Operating income 340,480 365,750Interest expense 22,330 10,000Earnings before taxes 318,150 355,750Taxes (35%) 111,353 124,512Earnings after taxes 206,797 231,238Preferred stock dividends 20,000 20,000Earnings available to common stockholders 186,797 211,238Shares outstanding 100,000 100,000Earnings per share $1.87 $2.11a. What is the percentage increase in sales between 2007 and 2008?b. What is the percentage increase in earnings after-tax between 2007and 2008?c. Assume you are asked why earnings after taxes increasedpercentagewise more rapidly than sales. Take each expense account(from cost of goods sold through taxes) as a percentage of sales forS2-42 each year and indicate whether it was a contributor or detractor fromthe superior growth in earning after taxes. Remember decliningpercentage “costs” contribute to profit. Also large amounts such ascost of goods sold have a greater impact than smaller amounts suchas depreciation or interest.d. If cost of goods sold could be reduced to 33 percent of sales in 2007while all else remained constant (with the exception of taxes whichremain at 35 percent of earnings before taxes), what would earningsper share be in 2008?e. Now return to the original income statements (i.e. disregardquestion d). What is the cash flow for each year (earnings after taxesplus depreciation)? What is the percentage change from 2007 to 2008.f. In 2008, add depreciation to operating income to get cash flow fromoperating activities. Then subtract out $20,000 for preferred stockdividends and assume there are $40,000 in capital expenditures,what is free cash flow?g. Assume Morton Industries is considering buying all its stock backwith borrowed funds (a leveraged buyback). One of the lender’srequirements is that 10 times free cash flow (from question f) mustbe at least equal to the total value of the company. The total value ofthe company in 2008 is equal to earnings per share times the firm’sP/E ratio (which is 19) times shares outstanding. Figure out the value of 10 times free cash flow. Then figure out thetotal value of the firm. Would the firm meet the lender’srequirement?CP Solution:a. Sales ? 2008 $923,147 Sales ?2007 877,200 Change$ 45,947Change $45,947 CP 3-1. (Continued)= = 5.24% Base amount $877,200 S2-43 CP 2-1. (Continued)b. Earnings after taxes ? 2008 $231,238 Earnings after taxes ? 2007 206,797 Change$24,441Change $24,441= = 11.82% Base amount $206,797 c. 2007 2008Cost of good sold $343,720 $344,160 = 39.18%= 37.28%Sales 877,200 923,147 Selling and admin. expense $81,000 $93,237 = 9.23%= 10.10%Sales 877,200 923,147 Depreciation expense $112,000 $120,000 = 12.77%= 13.00%Sales 877,200 923,147 Interest expense $22,330 $10,000 = 2.55%= 1.08%Sales 877,200 923,147 Taxes $111,353 $124,512 = 12.69%= 13.49%Sales 877,200 923,147 Contributors DetractorsCost of goods sold Selling and administrative expenseInterest expense Depreciation expenseTaxesNote: Because cost of goods sold involves the largest dollar amount, itsimpact is much greater.S2-44 CP 2-1. (Continued)d. Sales $923,147Cost of good sold (33 %) 304,639Gross profits 618,508Selling and administrative expense 93,237Depreciation Expense 120,000Operating income 405,271Interest expense10,000Earnings before taxes 395,271Taxes (35% of E.B.T.) 138,345Earnings after taxes 256,926Preferred stock dividends20,000Earnings available to commonstockholders 236,926Shares outstanding 100,000Earnings per share $2.37e. 2007 2008Earnings after taxes $206,797 $231,238Depreciation 112,000120,000Cash flow $318,797 $351,238f. Operating income ?2008 $365,750+Depreciation120,000Cash flow from operating activities $485,750–Preferred stock dividends 20,000–Capital expenditures 40,000Free cash flow $425,750g. Free cash flow $425,750Multiplier 10Total $4,257,500S2-45 "