Question

Richmond Rent-A-Car is about to go public. The investment banking firm of Tinkers, Evers & Chance is attempting to price the issue. The car rental industry generally trades at a 25 percent discount below the P/E ratio on the Standard & Poor’s 500 Stock Index. Assume that index currently has a P/E ratio of 30. The firm can be compared to the car rental industry as follows:

  

	Richmond	Car Rental Industry
Growth rate in earnings per share	14%	10%
Consistency of performance	Increased earnings 4 out of 5 years	Increased earnings 3 out of 5 years
Debt to total assets	35%	40%
Turnover of product	Slightly above average	Average
Quality of management	High	Average

   

Assume, in assessing the initial P/E ratio, the investment banker will first determine the appropriate industry P/E based on the Standard & Poor’s 500 Index. Then a .50 point will be added to the P/E ratio for each case in which Richmond Rent-A-Car is superior to the industry norm, and a .50 point will be deducted for an inferior comparison.

  
On this basis, what should the initial P/E be for the firm? (Round your answer to 1 decimal place.)

Answer 1

75% of the S&P 500 Stock Index = 75% x 30 = 22.5

Industry Comparisons

Growth rate in earnings per share-superior                       + ½

Consistency of performance-superior                               + ½

Debt to total assets-inferior + ½

Turnover of product-inferior +½

Quality of management-superior                                       + ½

5/2

Initial P/E ratio = 22.5 + 5/2 = 25 ANSWER