Question #70

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: 26

Status: Correct

Correct Answer: A

Part of Context Group: Q70-71 First in Group
Shared Context
- Based on a comparison of the actual trailing P/FCFE ratio compared to the justified trailing P/FCFE ratio (based on Davenport's FCFE valuation model) for 2008, Sanford is: A) overvalued because the actual P/FCFE ratio is greater than the justified P/FCFE ratio for 2008. B) correctly valued because the actual P/FCFE ratio is equal to the justified P/FCFE ratio for 2008. C) undervalued because the actual P/FCFE ratio is less than the justified P/FCFE ratio for 2008.
Question
Based on a comparison of the actual trailing P/adjusted CFO ratio compared to the industry median trailing P/adjusted CFO per share ratio for 2008, Sanford:
Answer Choices:
A. is correctly valued relative to the industry benchmark because Sanford’s P/adjusted CFO ratio is equal to the industry median, despite slightly higher systematic risk and lower 5-year earnings growth
B. is overvalued relative to the industry benchmark because Sanford’s P/adjusted CFO ratio is higher than the industry median, despite slightly higher systematic risk and lower 5-year earnings growth
C. may be undervalued relative to the industry benchmark because Sanford’s P/adjusted CFO ratio is higher than the industry median, despite slightly higher systematic risk and lower 5-year earnings growth
Explanation
Sanford's adjusted CFO is equal to net income plus depreciation minus the increase in net working capital (excluding cash and notes payable) plus after-tax interest expense: Sanford is overvalued relative to the industry benchmark because its P/adjusted CFO ratio is higher than the industry median of 2.0, despite slightly higher systematic risk (as measured by beta) and a lower 5-year earnings growth forecast.
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