Sarah Bailey is analyzing two stocks in the semiconductor industry. It is her intention to assign a P/E of 16 to the average firm in the industry. However, she will assign a 20 percent premium to the P/E of a company that uses conservative financing in its capital structure. This is because of the highly cyclical nature of the industry.
Two firms in the industry have the following financial data:

a. Compute return on stockholders€™ equity for each firm. Use the Du Pont Method of analysis. Which is higher?
b. Compute earnings per share for each company. Which is higher?
c. Applying the 20 percent premium to the P/E ratio of the firm with the more conservative financial structure and the industry P/E ratio of the other firm, which firm has the higher stock price valuation?

Net income Sales Sales Total assets Debt Total assets Earnings Shares Palo Alto Semiconductors Burr Ridge Semiconductors 5.0% 2.1x 60% $40 million $16 million 4.2% 30% $15 million $6.25 million