Finance Theories, Case Analysis, and Valuation. January 12, 2006. FBE 532 Objectives. Analyze and communicate implications of financial theory using cases Understand finance careers and functions Refine and expand specific financial analytical skills Responsibility for learning is with you
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January 12, 2006
Implied Stock Price
Source: Compustat (Wharton) Raios for 1995
Using an average stock price of $37, firm value is estimated to be $37 10m = $370 million
Implied Firm Value
Firm value is estimated to be $63.6 million
Implied Firm Value
Firm value is estimated to be $356.0 million
Remember when using P/E ratios that the estimated value is the value of equity, not firm value.
Suppose Greens carried $114 million of debt. With equity of $250 million and debt of $114, firm value is now V = E + D = $364 million.
How does this affect value using P/S ratios?Pitfalls in Comparables: I
Are the comparables really comparable? Firms differ in many significant dimensions including
Risk (most obviously capital structure; note that Greens equity value was unchanged by the fact that it carried debt. Is this realistic?Pitfalls in Comparables: II
Suppose the unobserved true relation between stock price and earnings is
Price = $9.00 + 12EPS
For Vons, say EPS =$1.50, so Price = $27 and P/E =18
For Greens, we have value = $9.00 +12 x 2 = $33
The multiples approach misprices by $4.00 or twelve percent of firm value -- other relations could be off more.
The Capital Asset Pricing Model states that the expected return on an asset is
Beta measures the sensitivity of the stock’s return to the return on the market portfolio. Note that beta depends on the firm’s leverage.