Question

1. Two potential acquisition candidates, AJAX and COMET, exhibit price to cash flow ratios of 6...

1. Two potential acquisition candidates, AJAX and COMET, exhibit price to cash flow ratios of 6 and 4, respectively. AJAX’s cash flows per share are expected to grow at a 12% annual rate and COMET’s at a more modest 10% rate. AJAX’s current cash flow per share is $4, and COMET’s is $5 million. AJAX’s current share price is $28 and Comet’s is $16. Which of the two firms is more attractive based on a ranking of their PEG ratios as an acquisition target? 10 points


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Answer #1

Ajax

PEG Ratio = Price to Cash Flow Ratio/Expected Annual Growth Rate of Cashflow

= 6/12

= 0.50

Implied Share Price = PEG Ratio*Expected Annual Growth Rate of Cashflow*Current Cash Flow Per Share

= 0.50*12*$4

= $24

COMET

PEG Ratio = Price to Cash Flow Ratio/Expected Annual Growth Rate of Cashflow

= 4/10

= 0.40

Implied Share Price = PEG Ratio*Expected Annual Growth Rate of Cashflow*Current Cash Flow Per Share

= 0.40*10*$5

= $20

Decision

Particulars Ajax Comet
Current Share Price ($) $28 $16
Implied Share Price ($) $24 $20

By Considering the above analysis, we come to conclusion that Comet is undervalued while Ajax is overvalued. So, Comet is more attractive as an acquisition target based on a ranking of PEG ratios.

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