TRADING COMPS MODELING WALL
STREET PREP FINAL PAPER QUESTIONS
AND SOLUTIONS
◉ Price to book ratio
Answer: 1. Equity value / Book value of equity
2. Equity value per share / Book value of equity per share
3. Book value is often adjusted to exclude goodwill (tangible book
value)
Compares market value of equity to book value of equity
Solves only one period problem of PE ratios
For financial institutions, whose equity is marked to market, also
solves some of historical cost problems
◉ Price to book issues
Answer: For non-financials, book value usually not an accurate
measure of true equity value bc of the historical nature of the
balance sheet
Book value may be negative (large historical losses) making the
ratio not meaningful
◉ Price to book most appropriate for...
Answer: Banks/manufacturing/other asset-intensive businesses
, ◉ Price to book underlying value driver`
Answer: ROE
Cost of equity
g
ROE-g / Cost of equity-g
◉ EV/EBIT
Answer: Enterprise value / Earnings before interest and taxes
Isolates core operations without impact of financing decision
(interest expense) and taxes
◉ EV/EBIT issues
Answer: Unadjusted EBIT is accounting measure of profitability,
which includes noncash expenses (D&A), nonrecurring items, and
differing assumptions from firm to firm which reduces quality of
comparison. These are often adjusted for comparability
◉ EV/EBIT most appropriate for
Answer: Companies with positive operating income
Service-based businesses (low capital-intensive firms)
Business with varying levels of capital intensity
◉ Underlying value driver
Answer: ROIC - g / ROIC x (wacc-g) x (1-tax rate)
STREET PREP FINAL PAPER QUESTIONS
AND SOLUTIONS
◉ Price to book ratio
Answer: 1. Equity value / Book value of equity
2. Equity value per share / Book value of equity per share
3. Book value is often adjusted to exclude goodwill (tangible book
value)
Compares market value of equity to book value of equity
Solves only one period problem of PE ratios
For financial institutions, whose equity is marked to market, also
solves some of historical cost problems
◉ Price to book issues
Answer: For non-financials, book value usually not an accurate
measure of true equity value bc of the historical nature of the
balance sheet
Book value may be negative (large historical losses) making the
ratio not meaningful
◉ Price to book most appropriate for...
Answer: Banks/manufacturing/other asset-intensive businesses
, ◉ Price to book underlying value driver`
Answer: ROE
Cost of equity
g
ROE-g / Cost of equity-g
◉ EV/EBIT
Answer: Enterprise value / Earnings before interest and taxes
Isolates core operations without impact of financing decision
(interest expense) and taxes
◉ EV/EBIT issues
Answer: Unadjusted EBIT is accounting measure of profitability,
which includes noncash expenses (D&A), nonrecurring items, and
differing assumptions from firm to firm which reduces quality of
comparison. These are often adjusted for comparability
◉ EV/EBIT most appropriate for
Answer: Companies with positive operating income
Service-based businesses (low capital-intensive firms)
Business with varying levels of capital intensity
◉ Underlying value driver
Answer: ROIC - g / ROIC x (wacc-g) x (1-tax rate)
