You are comparing the price to book ratio of 1stSpringfield Bank to other banks.

Question

You are comparing the price to book ratio of 1stSpringfield Bank to other banks. 1stSpringfield has a price to book ratio of 2 and a return on equity of 16%. The average price to book ratio across all banks is 1.2 but you have run a regression of price to book against return on equity across banks and arrived at the following: PB = 0.72 + 8 (ROE) (for example, if a firm has 10% ROE, PB=0.72+8*0.1=1.52) Based on this regression, which of the following conclusions would you draw? 1stSpringfield is undervalued (cheap) 1stSpringfield is overvalued (expensive) 1stSpringfield is fairly valued.

Explanation / Answer

Answer:b) istspringfield is overvalued.

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