Question #20
Reading: Reading 22 Market-Based Valuation - Price and Enterprise Value Multiples
PDF File: Reading 22 Market-Based Valuation - Price and Enterprise Value Multiples.pdf
Page: 7
Status: Correct
Correct Answer: A
Question
The Lewis Corp. had revenue per share of $300 in 2001, earnings per share of $4.50, and paid out 60% of its earnings as dividends. If the return on equity (ROE) and required rate of return of Lewis are 20% and 13% respectively, what is the appropriate price/sales (P/S) multiple for Lewis?
Answer Choices:
A. 0.12
B. 0.18
C. 0.19. An analyst has gathered the following fundamental data: Firm A Firm A Firm B Firm B Strategy High Margin Low Volume Low Margin High Volume High Margin Low Volume Low Margin High Volume Payout Ratio 40% 40% 40% 40%
Explanation
Profit Margin = EPS / Sales per share = 4.50 / 300 = 0.015 or 1.5%.
Expected growth in dividends and earnings = ROE × (1 − payout ratio) = 0.20 × 0.40 = 0.08
or 8%.
P0/S0 = [profit margin × payout ratio × (1 + g)] / (r − g) = [0.015 × 0.60 × (1.08)] / (0.13 −
0.08) = 0.1944.
(Module 22.4, LOS 22.i)
An analyst has gathered the following fundamental data:
Firm A
Firm A
Firm B
Firm B
Strategy
High Margin
Low Volume
Low Margin
High Volume
High Margin
Low Volume
Low Margin
High Volume
Payout Ratio
40%
40%
40%
40%
Required Rate of Return
11%
11%
11%
11%
Growth Rate in Dividends
9%
5%
5%
7%
Sales/Book Value of Equity
1.5
4.5
1.0
3
Profit Margin
10%
2%
9%
4%
Book Value
$150
$150
$125
$125