Question #53
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: 18
Status: Incorrect
Correct Answer: A
Your Answer: B
Question
Margin and Sales Trade-off for CVR, Inc. and Home, Inc., for Next Year Firm Strategy Retention Rate Profit Margin Sales/Book Value 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 CVR, Inc., has a required return for shareholders of 10%, what is its appropriate leading price-to-sales (P/S) multiple if the firm undertakes the high margin/low volume strategy?
Answer Choices:
A. 1.46
B. 0.80
C. 0.20
Explanation
g = Retention Rate × Profit Margin × Sales/book value of equity = 0.20 × 0.08 ×
1.25 = 0.02.
If profit margin is based on the expected earnings next period,
Leading P/S = (profit margin × payout ratio) / (r − g) = (0.08 × 0.80) / (0.10 − 0.02) =
0.80.