SENSITIVITY OF THE THEORETICAL MODELS OF VALUE- EARNINGS AND VALUE-TO-BOOK TO CHANGES IN ASSUMPTIONS. This problem explores the sensitivity of the value-earnings and value-to-book models to changes in underlying assumptions. We recommend that you design a computer spread- sheet to perform the calculations, particularly for the value-to-book ratio.
Required
a. Assume that current period earnings per share were $1.00 for each of the following scenarios. Compute the value-earnings ratio based on projected one-year-ahead earnings under each of the following sets of assumptions:
|
Scenario
|
Cost of Equity Capital
|
Growth Rate in Earnings
|
|
A
|
0.15
|
0.06
|
|
B
|
0.15
|
0.08
|
|
C
|
0.15
|
0.10
|
|
D
|
0.13
|
0.06
|
|
E
|
0.13
|
0.08
|
|
F
|
0.13
|
0.10
|
|
G
|
0.11
|
0.06
|
|
H
|
0.11
|
0.08
|
|
I
|
0.11
|
0.10
|
b. Assess the sensitivity of the value-earnings ratio to changes in the cost of equity capital and changes in the growth rate.
c. Compute the value-to-book ratio under each of the following sets of assumptions. Assume zero abnormal ROCE in the periods following the number of years of excess earnings.
|
Scenario
|
ROCE
|
Cost of Equity Capital
|
Dividend Payout Percentage
|
Years of Excess Earnings
|
|
A
|
0.20
|
0.13
|
0.30
|
10
|
|
B
|
0.18
|
0.13
|
0.30
|
10
|
|
C
|
0.14
|
0.13
|
0.30
|
10
|
|
D
|
0.18
|
0.15
|
0.30
|
10
|
|
E
|
0.18
|
0.11
|
0.30
|
10
|
|
F
|
0.18
|
0.13
|
0.40
|
10
|
|
G
|
0.18
|
0.13
|
0.20
|
10
|
|
H
|
0.18
|
0.13
|
0.30
|
15
|
|
I
|
0.18
|
0.13
|
0.30
|
20
|
d. Assess the sensitivity of the value-to-book ratio to changes in the assumptions made about the various underlying variables.