Section 1 PE ratio warmups, (18 points possible) VA1

1a. If a firms eps is expected to be $4 next year, and you believe a p/e of 20 is justified, what is the value
of this stock?

The value of the stock is $80 per share.

1b. If the price for the above stock is 100, is it a buy, sell or hold?

This stock is a sell.

1c. What if the price drops the next day to 50? Is it now a buy, sell, or hold?

This is a buy.

2a. If a firms eps is expected to be $5 next year, and you believe a p/e of 23 is justified, what is the value
of this stock?

The value of this stock is $115.

2b. If the price for the above stock is 100, is it a buy, sell or hold?

BUY!

2c. What if the price drops the next day to 115? Is it now a buy, sell, or hold?

HOLD, ITS AT THE SAME PRICE!

3a. If a firm currently has negative eps but eps is expected to be $1.00 per share next year, and you
believe a p/e of 20 is justified, what is the value of this stock?

1. If the price for the above stock is now 12, is it a buy, sell or hold?

It is a buy, its undervalued.

2. If your boss believes eps next year will only hit 50 cents rather than a dollar, what is the value of
the stock according to her?

Its low.

3. Is the above stock a buy, sell or hold for your boss?

It would be a buy still.

Section 2. Valuation analysis (70 points possible):

Consider the data from these three retailers. Note the expected return of the market, RM, and the risk
free rate and the average PE multiple for the retailer industry are at the top left…
1. Calculate the forward PE ratio for each stock, show your work:

GME: 73.7

BBBY: 36 is price

0.6 plus 217% gain is 1.90 eps for stock next year

Next year eps is 1.90 so 36/1.90 is 18.9 which is the new P/E

ULTA: Current price is 290 and eps is 3.97 but grows 11% next year to 4.41 so

290/4.41 = 65.8 is the new P/E

2. Your boss wants you to determine the value for each stock using the average retailer’s PE, provided
at the top left of the table (times the forward eps you calculated). Calculate the value for each firm,
and then indicate below if it is a buy, sell, or hold:

GME BBBY ULTA

Value is: 1.9*40 = 76 1.90*40 = 76 4.41*40 = 176.4
Is a buy, sell, or hold? 76 IS MUCH LESS 76 IS MORE THAN THE 176 IS MUCH LESS
Type one choice in THAN THE CURRENT CURRENT PRICE OF 36 THAN CURRENT PRICE
each box PRICE OF 140 SO ITS so its UNDERVALUED, OF 290 so its
OVER-VALUED; SELL! BUY!!!!! OVERVALUED! SELL!!!

3. Gordon Dividend.
Value = dividend in one year / ( k - g) (use decimals for k and g, not whole numbers)

And recall the capm: k = rf +B(rm – rf)

Fill-in each of the components to calculate Gordon, for BBBY AND ULTA only, below…using the data
from the table to start. Then calculate their value, using the Gordon formula. Then indicate if it is a buy,
sell, or hold

GMEGME BBBY ULTA

Dividend 1: SKIP GME: Since firm 0.65 - GIVEN 1.5 – GIVEN
pays no dividend, can’t
use Gordon, so skip it
K (use the CAPM RF = 1, RM = 9 AND RF = 1, RM = 8, BETA IS
formula) THIS BETA IS 1.59; SO 1.77, so K = 13.39%
K = 13.72%
G .05 – GIVEN .08 GIVEN
Value .65 / .1372-.05 = 7.45 1.5/.1339-.08 = 27.83
YOU CALCULATE
Is it a buy, sell, or BUY SELL
hold? Type one choice
in each box
4. Last: what is the expected rate of return for GME, if we assumed that its beta is actually now
equal to 3? (calculate CAPM):

K = 1 +3(8-1) = 22 err

Last section: Financial Statements

Recall: ROE = NI/Owner’s equity OR profit margin * asset turnover * Financial leverage and

Net income/sales = profit margin;

Sales / Total assets = asset turnover

Total assets / Owner’s Equity = Financial leverage

Use the data (in millions) in the below table to calculate the numbers in each of the empty boxes:

GME BBBY ULTA

Sales 2,970 7,500 3,450
Net Income 50 550 400
Total assets 3,500 7,500 1,500
Owner’s Equity 500 3,750 1,000

Calculate:
Profit margin: 1.7% 7.3% 11.6%
Asset turnover: .84 1.00 2.3
 Financial leverage 7… A LOT OF DEBT! 2 1.5
ROE 10% 14.6% 40%

Given what you came up with, if all you cared about was profit margin, which firm would you prefer?

If profit margin was the only factor, one would prefer ULTA, because the profit margin is the highest.

Speed, or asset turnover is also important for retailers. So if you just focused on the speed ratio, which
firm wins?

ULTA would win again, it’s the highest!

Return on assets (ROA) is found by multiplying the profit margin by the speed ratio. It is an excellent
stat to use to compare a firm’s overall operational efficiency (ignoring the financing decisions made by
top management). Calculate each firm’s ROA and present it below:

GME: 1.4% BBBY: 7.3% ULTA: 26.68%

Which firm does best on its ROA (highest one wins)?

ULTA.

Which firm do you like best and why?

I like ULTA the best, it has the best stats and will make me the most cash in the end.

Extra credit: what is a short squeeze?