59533341-FM11-Ch-07-Instructors-Manual-1

Calculate the average entity ratio for a sample of

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Unformatted text preview: le of comparable firms. For example, V/EBITDA, V/customers. Then find the entity value of the firm in question. For example, multiply the firm¶s sales by the V/sales multiple, or multiply the firm¶s # of customers by the V/customers ratio. The result is the total value of the firm. Subtract the firm¶s debt to get the total value of equity. Divide by the number of shares to get the price per share. There are problems with market multiple analysis. (1) It is often hard to find comparable firms. (2) The average ratio for the sample of comparable firms often has a wide range. For example, the average P/E ratio might be 20, but the range could be from 10 to 50. How do you know whether your firm should be compared to the low, average, or high performers? l. Why do stock prices change? Suppose the expected D1 is $2, the growth rate is 5 percent, and rs is 10 percent. Using the constant growth model, what is the impact on stock price if g is 4 percent or 6 percent? If rs is 9 percent or 11 percent? Answer: Using the constant growth model, the price of a stock is P0 = D1 / (rs ± g). If estimates of g change, then the price will change. If estimates of the required return on stock change, then the stock price will change. Notice that rs = rRF + (rpm)bi, so rs will change if there are changes in inflation expectations, risk aversion, or company risk. The following table shows the stock price for various levels of g and rs. rs 9% 10% 11% Mini Case: 7 - 24 g 4% 40.00 33.33 28.57 g 5% 50.00 40.00 33.33 g 6% 66.67 50.00 40.00 m. What does market equilibrium mean? Answer: Equilibrium means stable, no tendency to change. Market equilibrium means that prices are stable--at its current price, there is no general tendency for people to want to buy or to sell a security that is in equilibrium. Also, when equilibrium exists, the expected rate of return will be equal to the required rate of return: › r = D1/P0 + g = r = rRF + (rM - rRF)b. n. If equilibrium does not exist, how will it...
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This note was uploaded on 09/14/2012 for the course MBA 341 taught by Professor Jamnadas during the Spring '12 term at LIM.

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