AF3313
AF3313-BUSINESS FINANCE
Individual Assignment
Au Kin Cheung, Gap (12059052d)
STOCK PRICE OF RAGAN COMPANY
From the question, the basic information is listed as follow:
The PE ratio is calculated by:
Stock Price / EPS
The average PE ratio is equal to the industry’s benchmark PE :
Sum of individual company PE ratio/ Total number of companies
From the above industry’s benchmark PE ratio:
Company
Total number of shares
Reported Earnings
EPS
Stock Price
Regan Thermal System
100000
US$320,000
US$3.20
US$52.01
Since the PE ratio = Stock Price / EPS
By EPS * industry’s benchmark PE ratio, the Ragan’s stock price can be found.
Therefore Ragan stock price = US$52.01.
Comment on PE ratio and another method for stock valuation
“Caution is warranted when using PE ratio to value stocks.” In order to discuss this statement, we should first know about how the PE ratio is derived and used in the market.
Price to Earning (PE) ratio= Stock Price/Earnings Per Share (EPS)
PE ratio is also named as PE multiple. In a stock market, comparable firms are assumed to have similar multiples. Hence, it is generally assumed that similar firms have similar PE ratio. In order to value a stocks of a firm, the average PE ratio across the industry of that firm is calculated to act as a multiple. Therefore, it is essential for the average multiple should be calculated across firm in an industry with similar characteristics.
Furthermore, even firms in the same industry are likely to have different multiples. For example, on a particular day in May 2011, the PE ratio of Google was slightly above 20 while Microsoft’s PE was 10. Such a big different is due to the different growth opportunity between the 2 companies. In fact, the PE ratio is likely a functions of the following 3 factors:
1. Growth Opportunity: Positively related
2. Risk/Firm’s Discount rate: Negatively related
3. Accounting Practices: Positively related for firms using conservative accounting practices.
The above 3
Individual Assignment
Au Kin Cheung, Gap (12059052d)
STOCK PRICE OF RAGAN COMPANY
From the question, the basic information is listed as follow:
The PE ratio is calculated by:
Stock Price / EPS
The average PE ratio is equal to the industry’s benchmark PE :
Sum of individual company PE ratio/ Total number of companies
From the above industry’s benchmark PE ratio:
Company
Total number of shares
Reported Earnings
EPS
Stock Price
Regan Thermal System
100000
US$320,000
US$3.20
US$52.01
Since the PE ratio = Stock Price / EPS
By EPS * industry’s benchmark PE ratio, the Ragan’s stock price can be found.
Therefore Ragan stock price = US$52.01.
Comment on PE ratio and another method for stock valuation
“Caution is warranted when using PE ratio to value stocks.” In order to discuss this statement, we should first know about how the PE ratio is derived and used in the market.
Price to Earning (PE) ratio= Stock Price/Earnings Per Share (EPS)
PE ratio is also named as PE multiple. In a stock market, comparable firms are assumed to have similar multiples. Hence, it is generally assumed that similar firms have similar PE ratio. In order to value a stocks of a firm, the average PE ratio across the industry of that firm is calculated to act as a multiple. Therefore, it is essential for the average multiple should be calculated across firm in an industry with similar characteristics.
Furthermore, even firms in the same industry are likely to have different multiples. For example, on a particular day in May 2011, the PE ratio of Google was slightly above 20 while Microsoft’s PE was 10. Such a big different is due to the different growth opportunity between the 2 companies. In fact, the PE ratio is likely a functions of the following 3 factors:
1. Growth Opportunity: Positively related
2. Risk/Firm’s Discount rate: Negatively related
3. Accounting Practices: Positively related for firms using conservative accounting practices.
The above 3
References: 1. Ross, Westerfield, Jaffe, Lim, Tan and Wong, Corporate Finance, Asia Global Edition,McGraw-Hill, 2013.