Problem
Calculate the justified forward P/B ratio for a company with the following characteristics:
Profit margin = 4%
Total asset turnover = 1.6
Equity multiplier = 2
Dividend growth rate = 2%
Cost of equity = 7%
The formula for the justified forward P/B ratio is:
P/B = ROE / (r - g)
The return on equity (ROE) can be calculated using the DuPont model:
ROE = Profit Margin x Total Asset Turnover x Equity Multiplier
• What is the ROE?
• What is the justified forward P/B ratio?
• If the analyst assumes a profit margin of 3% instead of 4%, what is the new justified forward P/B ratio?