Weekly Challenge #6: Consistent Multiples

You have been asked to rank the following 5 companies from cheapest to most expensive on the basis of multiples of earnings. They are all in the same sector, have roughly the same expected growth in income in their operating businesses, have similar debt ratios and generate similar returns on equity on their operating investments.  You have been given the following information on the companies:

 Company Price/share # Common Shares (Primary) # Options Value/option Cash Balance Net Income Income from Cash A \$8.00 25 1 \$2.00 \$22.00 \$16.00 \$1.60 B \$15.00 5 2 \$5.00 \$10.00 \$6.50 \$0.50 C \$42.50 40 20 \$30.00 \$300.00 \$170.00 \$10.00 D \$7.90 10 8 \$2.00 \$5.00 \$7.50 \$0.30 E \$50.00 300 20 \$20.00 \$2,900.00 \$1,125.00 \$125.00

All of the values are in millions except for the price/share. The primary shares refer to actual shares outstanding and the value per option has been computed using an option pricing model.

1.     Compute the primary PE ratio for each company and rank the companies based upon the primary PE.

2.     Compute the fully diluted PE ratio for each company and rank the companies based up the fully diluted PE. Explain why the rankings change from the primary PE rankings.

3.     Compute a PE ratio that incorporates the options outstanding more appropriately (than the fully diluted approach) and rank the companies based upon this ratio. Explain why the ranking change from the fully diluted PE.

4.     Compute a PE ratio that incorporates both the options outstanding and the cash balances at each of the companies and rank the companies based upon this ratio. Explain why the ranking changes from the ratios that you computed in part 3.