This problem explores the sensitivity of the value-earnings and value-to-book models to changes in underlying assumptions. We recommend that you design a computer spreadsheet to perform the calculations, particularly for the value-to-book ratio.

Required
a. Assume that current period earnings per share were $1.00 for each of the following scenarios. Compute the value-earnings ratio based on projected one-year-ahead earnings under each of the following sets of assumptions:

b. Assess the sensitivity of the value-earnings ratio to changes in the cost of equity capital and changes in the growth rate.
c. Compute the value-to-book ratio under each of the following sets of assumptions. Assume zero abnormal ROCE in the periods following the number of years of excess earnings.

d. Assess the sensitivity of the value-to-book ratio to changes in the assumptions made about the various underlyingvariables.

Scenario Cost of Equity Capital 0.15 0.15 0.15 0.13 0.13 0.13 0.11 0.11 0.11 Growth Rate in Earnings 0.06 0.08 0.10 0.06 0.08 0.10 0.06 0.08 0.10 Cost of Equity Dividend Payout Years of Excess Earnings Scenario ROCE Capital Percentage 10 10 10 0.13 0.13 0.13 0.15 0.11 0.13 0.13 0.13 0.13 0.30 0.30 0.30 0.30 0.30 0.40 0.20 0.30 0.30 0.20 0.18 0.18 0.18 0.18 0.18 0.18 0.18 10 15 20