Jack retains 60% of earnings and earns 15% ROE. Jill retains 30% and earns 25% ROE. Compare their trailing P/E ratios at required returns of 10%, 12% and 14%.
- A.Which firm has the larger trailing P/E?
Price-Earnings Ratios
A.
| Required return | Jack P/E | Jill P/E |
|---|---|---|
| 10.000% | 43.60 | 30.10 |
| 12.000% | 14.53 | 16.72 |
| 14.000% | 8.72 | 11.58 |
The ranking depends on the required return. Equality occurs at approximately 11.0664%.
Price-Earnings Ratios
Olicrem earned 9,000 in 2017. Comparable pharmaceutical companies have payout 40%, required equity return 7.5% and ROE 8%. Value the company at the end of 2017, treating 9,000 as current earnings. Then reassess if Olicrem’s sustainable ROE is only 7%.
- A.Calculate the justified P/E and equity value.
- B.Calculate PVGO and reassess at ROE 7%.
- C.Interpret the investment policy.
A.
Equity = 139,733.33.
B.
Use next-period earnings for the no-growth benchmark.
New PVGO = -11,367.27.
C.
At ROE 8% reinvestment earns more than 7.5% and creates value. At ROE 7% it destroys value. If the 9,000 figure is instead treated as next-year earnings, omit the growth multiplier consistently in both the valuation and benchmark.