Question #135
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: 48
Status: Unattempted
Question
Herb McClain tells Cammy Oren that Kline Industries' expected dividend growth rate is 4.0%, ROE is 14%, and required return on equity (r) is 10%. Based on a justified P/B ratio compared to a P/B ratio (based on market price per share) of 1.55, Kline Industries is most likely:
Answer Choices:
A. correctly valued
B. undervalued
C. overvalued
Explanation
Justified P/B = (ROE − g) / (r − g). When the expected dividend growth is 4.0%, the justified
P/B = (0.14 − 0.04) / (0.10 − 0.04) = 1.67. This is greater than the P/B (at market) of 1.55.