Richmond Rent-A-Car is about to go public. The investment banking firm of Tinker

Question

Richmond Rent-A-Car is about to go public. The investment banking firm of Tinkers, Evers & Chance is attempting to price the issue. The car rental industry generally trades at a 25 percent discount below the P/E ratio on the Standard & Poor's 500 Stock Index. Assume that index currently has a P/E ratio of 25. The firm can be compared to the car rental industry as follows: Richmond Car Rental Industry 10% Growth rate in earmings per share Consistency of performance 12% Increased earnings Increased earnings Debt to total assets Tumover of product Quality of management 4 out of 5 years 39% Slightly below average High 3 out of 5 years 40% Average Average Assume, in assessing the initial P/E ratio, the investment banker will first determine the appropriate industry P/E based on the Standard & Poor's 500 Index. Then a .50 point will be added to the P/E ratio for each case in which Richmond Rent-A-Car is superior to the industry norm, and a .50 point will be deducted for an inferior comparison. On this basis, what should the initial P/E be for the firm? (Round your answer to 1 decimal place.) Initial P/E ratio

Explanation / Answer

Index PE = 25

Car Industry PE = (1-25%)*25 = 18.75

Richmond superior in 4 factors : growth rate, consistency, Quality management, Debt to total assets

Richmond infereior in 1 factor : turnover

Richmond PE = 18.75 + 4*(0.5) - 1*(0.5) = 20.25

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