As of February 2016, you are researching HouseDepot, Inc, a hypothetical company
ID: 2761461 • Letter: A
Question
As of February 2016, you are researching HouseDepot, Inc, a hypothetical company subject to cyclical demand for its services. HouseDepot shares closed at $76.85 on February 2016. You believe the 2011-2015 period reasonably captures average profitability Use a normalized EPS for HouseDepot based on the method of historical average EPS to calculate the P/E based on normalized EPS Use a normalized EPS for HouseDepot based on the method of average ROE to calculate the P/E based on normalized EPS Why we need to use normalized EPS?Explanation / Answer
A.Normalised EPS base on Historical Average EPS = Total of EPS of all years/ no of years
=( $3.76+$3.00+$2.47+$2.01+$1.57) / 5 years
=$2.56 Per share
P/E Ratio= Market price per share/EPS =$76.85/$2.56=30.02 times
B..Normalised EPS base on Average ROE = Average ROE * Book value per share of recent year(2015)
=((35.55%+25.42%+21.11%+17.44%+14.32%)5 )*$8.73
=(22.77%)**$8.73
= $1.99 Per share
P/E Ratio= Market price per share/EPS ==$76.85/$1.99=38.62 times
C. Normalized EPS is generally used when the EPS is negative and firm wants to calcualte the P/E ratio.Since a negative P/E ratio is not meaningful, we calcualte the ROE over a period of time say 5-10 year and then multiply with the present Book value of the company to get the reliable estimate of the EPS and then compute the P/E ratio.
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.