pbv - Book Value Multiples Aswath Damodaran Aswath...

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Aswath Damodaran 1 Book Value Multiples Aswath Damodaran
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Aswath Damodaran 2 Price-Book Value Ratio: Definition n The price/book value ratio is the ratio of the market value of equity to the book value of equity, i.e., the measure of shareholders’ equity in the balance sheet. n Price/Book Value = Market Value of Equity Book Value of Equity n Consistency Tests: If the market value of equity refers to the market value of equity of common stock outstanding, the book value of common equity should be used in the denominator. If there is more that one class of common stock outstanding, the market values of all classes (even the non-traded classes) needs to be factored in.
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Aswath Damodaran 3 Price to Book Value: Distribution PBV Ratio 1000 800 600 400 200 0 Std. Dev = 2.36 Mean = 2.39 N = 4866.00
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Aswath Damodaran 4 Price Book Value Ratio: Stable Growth Firm n Going back to a simple dividend discount model, n Defining the return on equity (ROE) = EPS 0 / Book Value of Equity, the value of equity can be written as: n If the return on equity is based upon expected earnings in the next time period, this can be simplified to, P 0 = DPS 1 r - g n P 0 = BV 0 *ROE*Payout Ratio *(1 + g n ) r-g n P 0 BV 0 = PBV = ROE*Payout Ratio*(1 + g n ) r-g n P 0 BV 0 = PBV = ROE *Payout Ratio r-g n
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Aswath Damodaran 5 Price Book Value Ratio: Stable Growth Firm Another Presentation n This formulation can be simplified even further by relating growth to the return on equity: g = (1 - Payout ratio) * ROE n Substituting back into the P/BV equation, n The price-book value ratio of a stable firm is determined by the differential between the return on equity and the required rate of return on its projects. P 0 BV 0 = PBV = ROE - g n r-g n
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Aswath Damodaran 6 Price Book Value Ratio for a Stable Growth Firm: Example n Jenapharm was the most respected pharmaceutical manufacturer in East Germany. n Jenapharm was expected to have revenues of 230 million DM and earnings before interest and taxes of 30 million DM in 1991. n The firm had a book value of assets of 110 million DM, and a book value of equity of 58 million DM. The interest expenses in 1991 is expected to be 15 million DM. The corporate tax rate is 40%. n The firm was expected to maintain sales in its niche product, a contraceptive pill, and grow at 5% a year in the long term, primarily by expanding into the generic drug market. n The average beta of pharmaceutical firms traded on the Frankfurt Stock exchange was 1.05. n The ten-year bond rate in Germany at the time of this valuation was 7%; the risk premium for stocks over bonds is assumed to be 5.5%.
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Aswath Damodaran 7 Estimating a Price/Book Ratio for Jenapharm n Expected Net Income = (EBIT - Interest Expense)*(1-t)* 1+g) = (30 - 15) *(1-0.4)* (1.05) = 9.45 mil DM n Return on Equity = Expected Net Income / Book Value of Equity = 9.45 / 58 = 16.29% n Cost on Equity = 7% + 1.05 (5.5%) = 12.775% n Price/Book Value Ratio = (ROE - g) / (r - g) = (.1629 - .05) / (.12775 - .05) = 1.46 n Estimated MV of equity = BV of Equity * Price/BV ratio = 58 * 1.46 = $ 84.50 mil DM
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pbv - Book Value Multiples Aswath Damodaran Aswath...

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