Financial statement analysis, 11th edition - page 648 - case 11-3, required part d. CASE 113

Accounting-Based Equity Valuation After careful financial statement analysis, we obtain these predictions for Colin Technology:

YEAR NET INCOME BEGINNING BOOK VALUE

1...........1034...................5308

2...........1130...................5292

3...........1218...................5834

4............1256.................6338

5............1278.................6728

6............1404.................7266

7............1546.................7856

Colin Technologys cost of equity capital is estimated at 13%.

CHECK (a) $7,205 (d) $8,644

Required:

a. Abnormal earnings are expected to be $0 per year after Year 7. Use the accounting-based equity valuation model to estimate Colins value at the beginning of Year 1.

b. Determine Colins PB ratio using the results in (a). Colins actual market-based PB ratio is 1.95. What do you conclude from this PB comparison?

c. Determine Colins PE ratio using the results in (a). Colins actual market-based PE ratio is 10. What do you conclude from this PE comparison?

d. If we expect Colins sales and profit margin to remain unchanged after Year 7 with a stable book value of $8,506, use the accounting-based equity valuation model to estimate Colins value at the beginning of Year

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8+

Net Inome 1034 1130 1218 1256 1278 1404 1546 1546

book value (begining) 5308 5292 5834 6338 6728 7266 7856 8506

residual income ____ _____ _____ ______ ______ _____ _____ ______

PV factor at 13% ____ ______ _____ ______ ______ ______ ______ _______