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
D1 = $1.20 x 1.15 = $1.38
($35.25 / $16.40). For the other three firms, the ratios are more conservative.
Market
Value
Book
Value
Market Value to
Book Value
Gilbert Enterprises
$35.25
$16.40
2.15
Reliance Parts
70.50
50.25
1.40
Standard Auto
24.25
19.50
1.24
Allied Motors
46.75
50.75
.92
But keep in mind that book value is a relatively meaningless concept because it is based on historical
cost. A more meaningful analysis relates market value to replacement value. In this instance, we see
that Gilbert Enterprises is the most conservatively valued of the four firms.
Market
Value
Replacement
Value
Market Value to
Replacement
Value
Gilbert Enterprises
$35.25
$43.50
.81
Reliance Parts
70.50
68.75
1.03
Standard Auto
24.25
26.00
.93
Allied Motors
46.75
37.50
1.25
What about dividends? In terms of dividend yield, only Standard Auto provides a higher return to its
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