Question

You are analyzing a private company that makes tires. You expect net income of $25 million

for the private company next year. There is a public company called Htires traded on the ASX

that operates in the same industry. Both of these companies have a cost of equity of 10%.

Analysts expect growth of 4% per year for Htires. Htires has a payout rate of about 85%, which

is expected to remain constant in the future. Do not consider other factors that are not stated

here.

(a) What is Htires’ forward P/E ratio?

(b) Assume that you found a forward P/E ratio of 20 in part (a). Do not use your actual answer

from part (a). If the private company and Htires are good comparables, what is your estimate

of the private company’s market capitalization?

Answer 1

(a) What is Htires’ forward P/E ratio?

Forward P/E ratio can be computed using the equation = Dividend Payout Ratio / (R – G) where

Dividend Payout Ratio = 85%

R = rate of return of 10%

G = Growth rate of 4%

Forward P/E ratio = 85%/(10%-45) = 85%/6% = 14.167

(b) what is your estimate of the private company’s market capitalization if forward PE is 20?

Forward PE = 20

Next year net income = $25 million

P/E Ratio = Market Capitalisation / Total Earnings or

Market Capitalisation = P/E Ratio * Total Earnings

Market Capitalisation = 20*$25 million = $500 Million