invic

An analyst is valuing a company with a dividend payout ratio of 0.35, a beta of 1.45, and an expected earnings growth rate of 0.08. A regression on comparable companies produces the following equation:
Predicted price to earnings (P/E) = 7.65 + (3.75 × dividend payout) + (15.35 × growth) − (0.70 × beta)What is the predicted P/E using the above regression?

A) 7.65.

B) 11.21.

C) 9.18.

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Predicted P/E = 7.65 + (3.75 × 0.35) + (15.35 × 0.08) − (0.70 × 1.45) = 9.1755

invic

An analyst is valuing a company with a dividend payout ratio of 0.55, a beta of 0.92, and an expected earnings growth rate of 0.07. A regression on comparable companies produces the following equation:
Predicted price to earnings (P/E) = 7.65 + (3.75 × dividend payout) + (15.35 × growth) − (0.70 × beta)What is the predicted P/E using the above regression?

A) 11.43.

B) 10.14.

C) 7.65.

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Predicted P/E = 7.65 + (3.75 × 0.55) + (15.35 × 0.07) − (0.70 × 0.92) = 10.14

invic

Industrial Light had earnings per share (EPS) of $5.00 past year, a dividend per share of $2.50, a cost of equity of 12%, and a long-term expected growth rate of 5%. What is the trailing price-to-earnings (P/E) ratio?

A) 7.50.

B) 3.75.

C) 7.14.

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P/E =
1 − b = 1 − (2.50/5.00) = 0.50P5 / E5 = (0.50 × 1.05) / (0.12 − 0.05) = 7.50

invic

A firm’s return on equity (ROE) is 15%, its required rate of return is 12%, and its expected growth rate is 7%. What is the firm’s justified price to book value (P/B) based on these fundamentals?

A) 1.60.

B) 1.71.

C) 0.63.

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P0/B0 = (ROE – g) / (r – g) = (0.15 – 0.07) / (0.12 – 0.07) = 1.60

invic

What is the appropriate price-to-sales (P/S) multiple of a stock that has a retention ratio of 45%, a return on equity (ROE) of 14%, an earnings per share (EPS) of $5.25, sales per share of $245.54, an expected growth rate in dividends and earnings of 6.5%, and shareholders require a return of 11% on their investment?

A) 0.158.

B) 0.227.

C) 0.278.

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Recall that profit margin is measured as E0 / S0. In this example, the profit margin is (5.25 / 245.54) = 0.0214. Thus:

P0 / S0 = [(E0 / S0)(1 − b)(1 + g)] / (r − g) = [0.0214(0.55)(1.065)] / (0.11 − 0.065) = 0.278

invic

A firm’s return on equity (ROE) is 14%, its required rate of return is 10%, and its expected growth rate is 8%. What is the firm’s justified price-to-book value (P/B) based on these fundamentals?

A) 3.00.

B) 2.00.

C) 2.75.

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The firm’s justified price-to-book value = (ROE – g) / (r – g) = (0.14 – 0.08) / (0.10 – 0.08) = 3.00

invic

What is the justified trailing price-to-earnings (P/E) multiple of a stock that has a payout ratio of 65% if the shareholders require a return of 10% on their investment and the expected growth rate in dividends is 6%?

A) 17.23.

B) 9.28.

C) 16.25.

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P0/E0 = (0.65 × 1.06) / (0.10 – 0.06) = 17.225

invic

Margin and Sales Trade-off for CVR, Inc. and Home, Inc., for Next Year
Firm	Strategy	Retention Rate	Profit Margin	Sales/Book Value (SBV) of Equity
CVR, Inc.	High Margin / Low Volume	20%	8%	1.25
CVR, Inc.	Low Margin / High Volume	20%	2%	4.00
Home, Inc.	High Margin / Low Volume	40%	9%	2.00
Home, Inc.	Low Margin / High Volume	40%	1%	20.0

Note: CVR, Inc., has a book value of equity of $80 and a required rate of return of 10%. Home, Inc., has a book value of equity of $100 and a required rate of return of 11%.
If Home, Inc., has a required return for shareholders of 11%, what is its appropriate leading price-to-sales (Po / S1) multiple if the firm undertakes the low margin/high volume strategy?

A) 1.00.

B) 0.20.

C) 0.80.

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g = Retention Rate × Profit Margin × SBV of equity = 0.40 × 0.01 × 20.0 = 0.08.
If profit margin is based on the expected earnings next period,
P/S = (profit margin × payout ratio) / (r − g) = (0.01 × 0.60) / (0.11 − 0.08) = 0.20.

invic

A firm has a payout ratio of 40%, a profit margin of 7%, an estimated growth rate of 10%, and its shareholders require a return of 14% on their investment. Based on these fundamentals, a reasonable estimate of the appropriate price-to-sales ratio for the firm (based on trailing sales) is:

A) 0.70.

B) 0.56.

C) 0.77.

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invic

An analyst has gathered the following fundamental data:

	Firm A	Firm B	Firm C	Firm D
Payout Ratio	75%
Required Rate of Return	12%	12%	12%	12%
Return on Equity (ROE)	20%	15%	30%	14%
Price/Book Value (PBV) Ratio		3.00	0.70	3.50

What is the PBV ratio for Firm A?

A) 1.25.

B) 2.14.

C) 0.71.

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The growth rate in dividends (g) = ROE(1 − payout ratio) = 0.20 × (1 − 0.75) = 0.05 or 5%. The PBV ratio = (ROE − g) / (r − g) = (0.20 − 0.05) / (0.12 − 0.05) = 2.14