CMA Final · Strategic Financial Management · Equity and Bond Valuation and Evaluation of Performance
A company's share trades at a price of Rs 150 and has earnings per share of Rs 10. Its industry average price-earnings ratio is 12. Using the industry P/E, what is the share's relative value and conclusion?
The share is worth Rs 120 on the industry P/E of 12 applied to EPS of Rs 10. Since the market price of Rs 150 is higher than this value, the share is overvalued relative to the industry.
- AValue Rs 120; share is overvaluedCorrect
- BValue Rs 120; share is undervalued
- CValue Rs 180; share is overvalued
- DValue Rs 150; fairly valued
Explanation
Value = EPS x industry P/E = 10 x 12 = Rs 120. Market price Rs 150 exceeds Rs 120, so the share is overvalued. Rs 180 comes from wrongly multiplying price by 1.2.
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