P/B calculation, problem 12, P. 563, Equity? problem, current, correct

Walex

You are give ROE=0.27, current EPS=$1.36, payout ratio=0.67, r=11.5%, g=9%
Find justified P/BV.

The way they did it in the answer is simply using P0/V0 = (ROE - g)/(r-g) = 7.2

However, the correct formula is derived as:

P0 = E0(1+g)(1-b)/(r-g), our good old formula. To find P0/BV0, divide both sides by BV0:

P0/BV0 = E0/BV0(1+g)(1-b)/(r-g), since E0/BV0 = current ROE = 0.27, then

P0/BV0 = 0.27(1.09)(0.67)/(.115-0.09) = 7.89

I think their answer is not correct, what do you think?

kkn006

I've seen the formula P0/V0 = (ROE - g) / (r - g) a ton of times and to be honest, that's probably what I would have plugged in. But I do see what you're saying, I've noticed that other formula too.

This is the best thing about multiple choice, if you didn't see your "7.89" in the answers, go back to the drawing board.

onelife1

ROE = E1/BV0

BV1 = BV0 + E1x(1-b) = B0 x (1+g)

return on equity, the equity that was available at the beginning to produce earnings at the end of the year.

SFoyil

pfcfaataf, you are right! But a small correction to the above: ROE = E0/BV1.

It's important to realize that when we say ROE we mean NI divided by latest figure for equity, not beginning equity...so it is current EPS divided by ending BV, or BV1.

Otabek

E1 depends on BV0.... your formula is wrong, dreary..

CP

tianxin

After making the adjustment as pfc indicated, it is correct. Just divide both side by (1+g) in this equation:

P0/BV0 = E0/BV0(1+g)(1-b)/(r-g)

ayodayo

pfcfaataf Wrote:
-------------------------------------------------------
> ROE = E1/BV0
>
> BV1 = BV0 + E1x(1-b) = B0 x (1+g)
>
> return on equity, the equity that was available at
> the beginning to produce earnings at the end of
> the year.

one correction, I switched meaning of b and 1-b in my head (temporarily I hope)

g = b x ROE and ROE stays defined as before ROE = E1/BV0

so

BV1 = BV0 + E1 x b = B0 x (1+g)

b_sea93

In RI valuation, these meanings get a bit messy. We need to keep a straight head as to the meaning of ROE0, ROE1, BV0, and BV1.

V0 = B0 + (ROE-r)/((r-g)

What's ROE here? Is it EPS0/B0? or EPS1/B0? or EPS1/B1?

bdavi77962

I use P/B = 1 + (ROE-r)/(r-g) as this is sure to be asked. Excess price over book equals excess earnings scaled to PV.

iteracom

pfcfaataf Wrote:
-------------------------------------------------------
> it is still ROE = E1/BV0
>
> V0 = B0 + (ROE-r)/((r-g) = B0 x (1 +
> (ROE-r)/((r-g))
>
>
> (1 + (ROE-r)/((r-g)) = (r - g + ROE-r)/(r-g) =
> (ROE - g)/(r-g) = E0/BV0(1+g)(1-b)/(r-g) if you
> want
>
> and you dont really need any calculations, just
> think about B as you initial investment and E as
> your interest/coupon/yield that you receive from
> the initial investment at the end of a period and
> you calculate holding period yield (or how it is
> called) => this is ROE
>
> there are of course some assumptions (to simplify
> it).


there was missing B0 in the middle of :
V0 = B0 + B0 x (ROE-r)/((r-g) = B0 x (1 + (ROE-r)/((r-g))

I am finished, I need to recharge myself.

speak to you tomorrow or today