Cara Partners has a client who has inquired about the valuation method best suited for comparison of companies in an industry that has the following characteristics:
• Principal competitors within the industry are located in the United States, France, Japan, and Brazil.
• The industry is currently operating at a cyclical low, with many firms reporting losses.
• The industry is subjected to rapid technological change.
Jones recommends that the client consider the following valuation ratios:
1. Price to earnings
2. Price to book value
3. Price to sales
a. Determine which one of the three valuation ratios is most appropriate for comparing companies in this industry. Support your answer with two reasons that make that ratio superior to either of the other two ratios.
The client also has expressed interest in economic value added (EVA) as a measure of company performance. Clarence Jones asks his assistant to prepare a presentation about EVA for the client. The assistant's presentation includes the following statements:
1. EVA is a measure of a firm's excess shareholder value generated over a long period of time.
2. In calculating EVA, the cost of capital is the weighted average of the after-tax yield on long-term bonds with similar risk and the cost of equity as calculated by the capital asset pricing model.
3. EVA provides a consistent measure of performance across firms.
b. Determine whether each of the statements is correct or incorrect and, if incorrect, explain why.
Explanations cannot repeat the statement in negative form but must indicate what is needed to make the statement correct.