PQ3_A - FINA537 Equity Valuation Solutions to Practice 3...

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FINA537 Equity Valuation Solutions to Practice 3 Questions 1. Relative valuation models measure a company’s valuation relative to another company normalized by some measure of size. The use of industry-average multiples overlooks the fact that companies, even in the same industry, can have drastically different expected growth rates, returns on equity, and capital structures. Price-earnings multiples commingle expectations about operating performance, capital structure and therefore discount rate, and non-operating items. To effectively analyze valuation multiples across an industry, use instead a multiple that is independent of capital structure. The price-to-earnings ratio does not meet this criterion. A second problem with the P/E ratio is that earnings include many non-operating items, such as restructuring charges and write-offs. Since many non-operating items are one-time events, incorporate them into the multiple measure may create a problem. Price-to-book and price-to-sales multiples assume similar growth rates and cost of
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PQ3_A - FINA537 Equity Valuation Solutions to Practice 3...

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