Question

1) A firm has total assets of 25 million TL. Its current assets is 10 million TL and fixed assets (machinery, real estate etc) is 15 million TL. This firm’s financial leverage is %45. Firm has 1 500 000 total outstanding shares with 900 000 shares trading at the stock market and one share sells 10 TL in the stock market. What is the firm’s Price/Book ratio( PD/DD)? Calculate the expected stock price and market cap if the average Price/Book ratio (PD/DD) of the comparable firms is 1,2. Would you invest in this stock?

Answer 1

Value of debt = total asset x financial leverage = 25 x 45% = 11.25

Book value of equity, BV = A - D = 25 - 11.25 = 13.75

Market value of equity = MV = P x N = 10 x 1,500,000 = 15 million

Hence, Price/Book ratio( PD/DD) = MV / BV = 15/13.75 = 1.09

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If Price/Book ratio( PD/DD) = MV / BV = 1.2

Hence, the market cap = MV = 1.2 x BV = 1.2 x 13.75 = 16.50

And the expected stock price = MV / N = 16.50 / 1.5 = 11.00

(Note in the denominator we have used 1.5 million i.e. 1,500,000 number of shares)

Since the actual price < expected price, the stock is curently undervalued and hence I will invest in this stock.