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ACCA Strategic Professional · Strategic Business Leader · Financial analysis and decision-making techniques

Kestrel Ltd is a private company with stable earnings. An investor values it on a P/E ratio taken from a listed competitor that is much larger and more diversified. Which implication is most appropriate for the valuation?

The value is likely overstated, so a discount is normally applied. A larger, diversified listed competitor has a higher P/E reflecting liquidity and lower risk, whereas a smaller private company is less marketable and riskier, so using the peer multiple unadjusted inflates its value.

  1. AThe value is likely to be overstated, so a discount for size, lack of marketability and risk is usually neededCorrect
  2. BThe value will be exact because P/E removes all differences between companies
  3. CThe value is understated because private companies have lower risk than listed ones
  4. DThe value need not be adjusted because P/E captures only past dividends

Explanation

A listed peer's P/E reflects liquidity, size and diversification. A smaller unlisted company is less marketable and riskier, so its P/E should be discounted. The claim that private firms are lower risk is wrong, and P/E is not based on dividends.

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