1. The conventional wisdom is that if a company increases its growth rate, the PE ratio should go up. When is this not true? a. When the company has a growth rate< riskfree rate b. When the company is risky c. Whey the company is safe d. When the company earns a ROE> Cost of equity e. When the company earns a ROE < Cost of equity 2. You are evaluating Zena Inc., a firm that is trading at a PE ratio of 15, with an expected growth rate of 20%, on a PEG ratio basis. The PEG ratio for the S&P 500 is 1.10. Based on the PEG ratios, which of the following statements would you subscribe to? 3. You are reading an analyst report that claims that banks collectively are cheap, because they are trading at 0.80 times book value of equity. You believe that the truth is that banks are perceived as riskier than they used to be. If the current return on equity for banks is 10% and the expected growth rate in perpetuity is 2%, what is the cost of equity that investors are attaching to banks? (Assume that banks collectively are in stable growth) Set 17 1. You are considering doing a leveraged buyout of Alameda Inc., a mature, manufacturing company. The company has an EV/EBITDA of 5, which is lower than the EV/EBITDA for the sector and the market. The company has EBITDA of $100 million, DA of $40 million, capital expenditures of $58 million, no working capital needs and a tax rate of 40%. If the cost of capital for the company is 10%, it earns a return on invested capital of 6% and is in stable growth, is the company cheap or expensive?
Concept Review Questions 2. Sisley Stores is a publicly traded company that expects revenues of $ 1 billion and after- tax operating income of $80 million, next year. It is in stable growth, growing 2% a year, and has invested capital of $800 million. If the cost of capital for the company is 8%, estimate the EV/Sales ratio for the company.
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