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Chapter_03web - Exercise 3 In September 2003 IBM traded at...

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EXERCISES FOR CHAPTER 3 With Solutions Exercise 1. An analyst decides to value Firm A on the basis of multiples of two comparable firms, Firm B and Firm C. Firm B trades at 16 times trailing earnings and C trades at 12 time trailing earnings. Firm A’s last reported eps was $2.34. Carry out the valuation. What reservations do you have about this valuation? (Refer to pp. 66-68) Solution Apply the average multiple for B and C to Firm A’s earnings: 14 x 2.34 = $32.76 per share The valuation is suspect: If Firms B and C are mispriced in the market, one will get the wrong valuation for A. Exercise 2 . Contrarian investors buy stocks with low P/E and P/B ratios; they judge that low multiples indicate that prices are too low and will increase. Why is this practice suspect? (Refer to p. 71) Solution A firm might have a low multiple for very good reasons. Indeed a low multiple firm could be overpriced. A multiple compares price to just one piece of information and ignores other information relevant to pricing. One ignores information at one’s peril.
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Unformatted text preview: Exercise 3 In September 2003, IBM traded at $89 per share with a total market capitalization of its equity of $153.97 billion. It reports $14 billion of debt, and sales for its latest year were $81.2 billion. Calculate the price-to-sales ratio. (Refer to p. 69) Solution Price-to-sales ratios must be unlevered for leverage does not affect sales. That is, they must be enterprise value -- the value of the assets without regard to financing by debt or equity -- relative to sales: P/S = ($153.97 + 14)/81.2 = 2.07 Exercise 4. An analyst forecasts that a stock’s dividends per share will be $2.00 in the coming year, and further expects dividends to grow at a rate of 3% per year indefinitely after that. Investors require a return of at least 9% for the stock. Value this stock. (Refer to p. 90) Solution Because dividends are expected to grow at a constant rate, the dividend discount model can be used: 03 . 09 . 00 . 2-= E V = $33.33...
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Chapter_03web - Exercise 3 In September 2003 IBM traded at...

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