You have been asked to rank the following 5 companies from cheapest to most expe
ID: 2750498 • Letter: Y
Question
You have been asked to rank the following 5 companies from cheapest to most expensive on the basis of multiples of earnings. They are all in the same sector, have roughly the same expected growth in income in their operating businesses, have similar debt ratios and generate similar returns on equity on their operating investments. You have been given the following information on the companies:
Company
Price/share
# Common Shares (Primary)
# Op6ons
Value/op6on
Cash Balance
Net Income
Income from Cash
A
$8.00
25
1
$2.00
$22.00
$16.00
$1.60
B
$15.00
5
2
$5.00
$10.00
$6.50
$0.50
C
$42.50
40
20
$30.00
$300.00
$170.00
$10.00
D
$7.90
10
8
$2.00
$5.00
$7.50
$0.30
E
$50.00
300
20
$20.00
$2,900.00
$1,125.00
$125.00
All of the values are in millions except for the price/share. The primary shares refer to actual shares outstanding and the value per option has been computed using an option pricing model.
Compute the primary PE ratio for each company and rank the companies based upon the primary PE.
Compute the fully diluted PE ratio for each company and rank the companies based up the fully diluted PE. Explain why the rankings change from the primary PE rankings.
Compute a PE ratio that incorporates the options outstanding more appropriately (than the fully diluted approach) and rank the companies based upon this ratio. Explain why the ranking change from the fully diluted PE.
Compute a PE ratio that incorporates both the options outstanding and the cash balances at each of the companies and rank the companies based upon this ratio. Explain why the ranking changes from the ratios that you computed in part 3.
Company
Price/share
# Common Shares (Primary)
# Op6ons
Value/op6on
Cash Balance
Net Income
Income from Cash
A
$8.00
25
1
$2.00
$22.00
$16.00
$1.60
B
$15.00
5
2
$5.00
$10.00
$6.50
$0.50
C
$42.50
40
20
$30.00
$300.00
$170.00
$10.00
D
$7.90
10
8
$2.00
$5.00
$7.50
$0.30
E
$50.00
300
20
$20.00
$2,900.00
$1,125.00
$125.00
Explanation / Answer
Part 1
Primary PE Ratio- Price of Share/ Earning per Share
Earning per Share=Net Income/((Price/share)*No. of Common Shares)
Company
EPS
P/E
A
0.080
100
B
0.087
173
C
0.100
425
D
0.095
83
E
0.075
667
Part 2
In Diluted PE ratio we will calculate EPS by including the no. of options in no. of common shares mentioned in the formula of Part 1. This is because Diluted EPS is calculated by assuming that everyone who has an instrument that can be converted into an equity share converts it into an equity share and so the total number of outstanding shares of the company increase, thereby reducing the EPS.
Company
Diluted EPS
P/E
A
0.079
101
B
0.076
196
C
0.074
575
D
0.079
100
E
0.073
684
Part 4:
In this we will remove the earning of the company which are happening on the cash balance present in the company and thus the earning in this EPS will be reflected on the Companies income rather than interest income. As the result the ranking of companies based in EPS and in turn PE ratio will further change.
Company
EPS excluding income from Cash balances
P/E
A
0.006
1234
B
0.026
567
C
0.041
1047
D
0.019
417
E
0.030
1670
Company
EPS
P/E
A
0.080
100
B
0.087
173
C
0.100
425
D
0.095
83
E
0.075
667
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.