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Gilbert Enterprises Case 13
Stock Valuation
Purpose: This case gives the student an opportunity to examine valuation concepts from both a
theoretical dividend valuation model approach and a price-earnings ratio approach. Because an initial
period of supernormal growth is assumed, a review of Appendix 10C is necessary for the case.
However, this appendix is not difficult to follow. The case also makes strong use of ratios as part of
the comparative P/E ratio analysis and should help the student better appreciate how ratios influence
valuation.
Relation to Text: The case should follow Chapter 10.
Complexity: The overall case is moderately complex and should require 1 hour.
Solutions
1. There are two steps involved in using the valuation of a supernormal growth firm.
A. Find the present value of supernormal dividends.
D0 = $1.20
Supernormal Dividends
Discount Rate
Ke = 10%
Present Value of Dividends During
the Supernormal Period
$3.93
B. Find the present value of the future stock price.
4
3
4 3 3
4
3
(1 ) 1.83, 6%
$1.83(1.06) $1.94
with .10
$1.94 $1.94 $48.50
.10 .06 .04
e
e
D
PK g
D D g D g
D
K
P
=-
= + = =
= =
=
= =
-
The present value of the future stock price is:
Stock Price after
Three Years
Discount
Rate 10%
Present Value of
Future Stock Price
$48.50 x .751 = $36.42
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Adding together, the values found in Step 1 and Step 2, the valuation is $40.35.
Because the stock is only selling in the market for 35 1/4, it appears to be undervalued.
2. Gilbert Enterprises has the second lowest P/E ratio of the four firms. Based on the financial infor-
mation provided in Figure 1, this does not appear to be appropriate. First of all, Gilbert Enterprises
Gilbert Enterprises also has the second highest return on stockholder’s equity. Only Reliance Parts
has a higher return, but its return is achieved solely as a result of its high debt ratio of 68 percent.
In evaluating debt utilization as a separate item, Gilbert Enterprises once again looks attractive
We get further insight by evaluating market value to book value as well as market value to
Market
Value
Book
Value
Market Value to
Book Value
But keep in mind that book value is a relatively meaningless concept because it is based on historical
Market
Value
Replacement
Value
Market Value to
Replacement
Value
What about dividends? In terms of dividend yield, only Standard Auto provides a higher return to its
stockholders.
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw-Hill Education.
In summarizing the variables under consideration, it appears that Gilbert Enterprises may be
undervalued relative to its competitors. While it has the second lowest P/E ratio, it has the fastest
3. Since the answer to questions 1 and 2 indicate the firm may undervalued, Albert Roth should
seriously consider recommending that the firm repurchase part of its shares in the marketplace.
There are two possible caveats. One is that the market tends to be efficient in the pricing of securities
Secondly, even if the stock is undervalued in the marketplace, the management of Gilbert Enterprises
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw-Hill Education.
