Question #55
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: 19
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 (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?
Answer Choices:
A. 0.80
B. 0.20
C. 1.00
Explanation
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.