You are a consultant and have been hired by the board of directors of P. R. Value,

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Question:

You are a consultant and have been hired by the board of directors of P. R. Value, Inc.—a privately held firm—to evaluate the reasonableness of the proposed implementation of an employment contract for an employee, which describes a method for valuing the company’s common stock. The employee owns 6,500 shares of the company’s stock and decides that now is the best time to leave the company. The company uses the valuation method described in the employment agreement to determine the price at which it buys back shares of employees who retire, die, or leave for other reasons. The salient parts of the contract are as follows:

“The price-earnings ratio for each of the comparable companies (C&B, FH, M&M, and A&A) shall be measured by dividing the average trading price for a corporation’s stock during the month of December preceding the date of death or retirement by such corporation’s reported audited earnings per share for the fiscal year preceding the date of death or retirement; average the four price-earnings ratios and multiply by the earnings per share of P. R. Value to determine the buyout price per share. The relevant information for the four comparable companies follows:

Using Reported Earnings	C&B	FH	M&M	A&A
Average Selling price	$42.86	47.30	47.74	43.54
Earnings Per Share	2.220	2.020	2.490	0.050

The A&A Company had a loss associated with a change in accounting principles of $2.05 per share in the most recent year. The earnings per share for P. R. Value, Inc. is $1.25.

(a) Calculate the buyout price assuming the contract does not allow any adjustment in the calculations for changes in accounting principles.

(b) Calculate the buyout price assuming the contract allows for an adjustment in the calculations for changes in accounting principles so that earnings per share of the comparable firms can be calculated on a pre-change basis. Which estimate is likely a more accurate indicator of the value of a share in P.R. Valuation?