# Kumquat Company Corporate Valuation

The stock beta, stock volatility, debt/value ratio, and price/earnings ratio of the Kumquat Company compared to some of their principal competitors are listed below.

Firm Beta Volatility D/V P/E

Kumquat 1.30 48% .25 10

Quince 1.35 30% .25 14

Soursop 1.30 34% .25 15

Feijoa 1.25 34% .25 16

Carombola 1.20 32% .25 13

Breadfruit 1.40 30% .25 17

S&P Index 1.00 .16% .20 20

Riskless (government) interest rates are 4.0%; expected inflation is 3.0%. All these firms (including Kumquat) have borrowing rates of about 6%. The corporate tax rate is 40%.

Kumquat currently has a stock price of $40, and pays no dividend.

A. How do Kumquat's future growth prospects compare with those of its competitors?

B. If the S&P stock index goes up 14% over the next year (10% more than cash), how much would you expect Kumquat to go up over the next year?

C. Quince is considering making an offer to acquire Kumquat. Quince believes it could run Kumquat more efficiently, and Kumquat would be 40% more profitable (as measured by equity earnings). If this is true, how much can Quince afford to bid?

D. Breadfruit is considering making an offer to acquire Kumquat. Breadfruit believes it could run Kumquat more efficiently, and Kumquat would be 20% more profitable (as measured by equity earnings). If this is true, how much can Breadfruit afford to bid?

E. What price should Kumquat sell for [in this acquisition, contested between Quince and Breadfruit]?

F. On a separate note, Kumquat's management is considering an investment in real assets, planning to spend 500; returning 100, 200, and 300 in years 1, 2, 3 (these are after-tax numbers). Should they make the investment?

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#### Solution Preview

A. How do Kumquat's future growth prospects compare with those of its competitors?

P/E ratio will be used to determine the Kumquat's future growth prospects.

In order to get a sense of how expensive or cheap a stock is, you have to look at earnings relative to the stock price and hence employ the P/E ratio. The P/E ratio takes the stock price and divides it by the last four quarters' worth of earnings. If AB ltd is currently trading at Rs. 20 a share with Rs. 4 of earnings per share (EPS), it would have a P/E of 5. Big increase in earnings is an important factor for share value appreciation. When a stock's P-E ratio is high, the majority of investors consider it as pricey or overvalued. Stocks with low P-E's are typically considered a good value. However, studies done and past market experience have proved that the higher the P/E, the better the stock.

First, one can obtain some idea of a reasonable price to pay for the stock by comparing its present P/E to its past levels of P/E ratio. One can learn what is a high and what is a low P/E for the individual company. One can compare the P/E ratio of the company with that of the market giving a relative measure. One can also use the average P/E ratio over time to help judge the reasonableness of the ...

#### Solution Summary

This explains the steps of valuation of organization and also the recommendations.