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 20 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 30. The firm can be compared to the car rental industry as follows:

  

   

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____

Richmond Car Rental Industry Growth rate in earnings per share 12% 10% Consistency of performance Increased earnings
4 out of 5 years Increased earnings
3 out of 5 years Debt to total assets 32% 40% Turnover of product Slightly above average Average Quality of management High Average

Explanation / Answer

P/E for the industry = 30 x (1 - 20%) = 24.0

Richmond is superior to the industry on the all five parameters.

Hence, Initial P/E ratio = 24.0 + 5 x 0.5 = 26.5

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