Exhibit 14.10 presents data on market-to-book (MB) ratios, ROCE, the cost of equity capital, and price-earnings (PE) ratios for seven pharmaceutical companies. (Note that PE ratios for these firms typically fall in the 30-35 range.) Exhibit 14.10 also provides historical data on the five-year average rate of growth in earnings and dividend payout ratios for each firm. The data on excess earnings years represent the number of years that each firm would need to earn a rate of return on common shareholders' equity (ROCE) equal to that in Exhibit 14.10 in order to produce value-to-book ratios that equal the market-to-book ratios shown. For example, Bristol-Myers Squibb would need to earn an ROCE of 48.9% for 58.3 years in order for the present value of the excess earnings over the cost of equity capital to produce a value-to-book ratio that matches the market-to-book ratio of 13.9.

REQUIREDAssume that market share prices for each firm are reasonably efficient. That is, do not simply assume that the market has over- or undervalued these firms. Considering the theoretical determinants of the market-to-book ratio, discuss the likely reasons for the relative ordering of these seven companies on their market-to-book ratios.

Exhibit 14.10 Selected Data for Pharmaceutical Companies (Problem 14.18) Cost of Dividend Excess Equity Capital Payout Growth in Earnings Years Company MB ROCE Ratio PE Earnings Bristol-Myers Squibb 13.9 0.489 0.134 0.77 32.4 0.068 58.3 Warner-Lambert 13.0 0.350 0.133 0.48 42.7 0.051 32.2 Eli Lilly 12.4 0.281 0.155 0.42 49.3 0.110 89.8 Pfizer 11.2 0.350 0.143 0.43 40.4 0.152 27.8 Abbott Laboratories 10.4 0.428 0.113 0.39 26.9 0.116 13.5 Merck 10.3 0.331 0.154 0.46 31.8 0.130 41.9 Wyeth 6.9 0.340 0.138 0.51 25.0 0.065 24.6