3. The following table provides summary data for Ethan Allen, on June 30, 2014 p

Question

3. The following table provides summary data for Ethan Allen, on June 30, 2014 per finance.yahoo.com (in millions). Analysts often use the observed PB ratio to infer market expectations regarding a company’s future performance based on assumptions. Ethan Allen Market value of equity $715.48 Book Value of Equity $367.57 ROE 12.23% For each of the cases determine implied parameter. Case 1: Analysts expect Ethan Allen’s ROE to be consistent with past performance and its discount rate to be 8.5%, calculate the implied growth rate. Case 2: Analysts are very uncertain about Ethan Allen’s future ROE but are fairly certain the company will grow at a rate of 6.5% and have a discount rate of 8.5%. Use this information to calculate the implied future ROE. 3. The following table provides summary data for Ethan Allen, on June 30, 2014 per finance.yahoo.com (in millions). Analysts often use the observed PB ratio to infer market expectations regarding a company’s future performance based on assumptions. Ethan Allen Market value of equity $715.48 Book Value of Equity $367.57 ROE 12.23% For each of the cases determine implied parameter. Case 1: Analysts expect Ethan Allen’s ROE to be consistent with past performance and its discount rate to be 8.5%, calculate the implied growth rate. Case 2: Analysts are very uncertain about Ethan Allen’s future ROE but are fairly certain the company will grow at a rate of 6.5% and have a discount rate of 8.5%. Use this information to calculate the implied future ROE.

Explanation / Answer

3.

Case 1:

Calculation of PB Ratio:

PR Ratio = Market value of equity / Book value of equity = $715.48 / $367.57

PB Ratio = 1.95

PB* Ratio = 0.95

Assumed Parameters

ROE = 12.23%

Discount Rate, re = 8.50%

Implied Parameter

Growth Rate = (re + [PB * re ] - ROE) / PB

= 8.5 + (0.95 * 8.5) - 12.23 / 0.95

= 8.5 + 8.075 - 12.23 / 0.95 = 4.57%

Case 2:

Assumed Parameters

Growth rate, g = 6.50%

Discount rate, re = 8.50%

Implied parameter

ROE = (PB * [re - g]) + re  

= (0.95 * [ 8.5 - 6.5]) + 8.50 = 10.40%

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