Question #38 - Reading 22 Market-Based Valuation - Price and Enterprise Value Multiples

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: 14

Status: Incorrect

Correct Answer: A

Your Answer: B

Shared Context

- If the appropriate adjustments to the five justified ratios are implemented following the launch of the new product line at Yantra, then: A) all five ratios will decline. B) four ratios will decline. C) three ratios will decline.

Question

In relation to Arda, Struma, and Tundzha, Beyan should opt for: Arda Struma Tundzha

Answer Choices:

A. P/B norm P/E P/E

B. P/B norm P/E P/S

C. P/E P/S P/E

Explanation

Arda is in financial hardship, which probably means the company has very low or even negative earnings rendering the P/E ratio meaningless. Struma operates in a very cyclical industry so earnings normalization is necessary to take into account the full impact of the business cycle. Taking the trailing price-to-sales ratio, (i.e., most recent twelve-month sales) would either inflate or deflate the ratio for a cyclical company depending on the stage of the cycle. Tundzha has a very different cost structure relative to its peer group. This indicates that the use of the price-to-sales ratio is not a good idea as that ratio completely ignores items below the sales line (i.e., ignores cross-sectional differences in profitability).

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