An independent investment advisor is examining shares of Claypool Manufacturing, Inc. for possible investment. In her examination, this investment advisor has gathered the following information:
Market discount rate: 12.5% per year
Observed Price/Earnings ratio: 14.25
Given this information, what is the Franchise Price/Earnings ratio for Claypool Manufacturing?
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A. B. C. D. E. F.B
The Franchise Factor method of value measurement is in many respects similar to EVA and MVA calculations. When examining a company using the franchise value approach, the observed price-to-earnings ratio is broken down into its two components - (1) the "base P/E," which is based on the Company's ongoing performance, and (2) a "franchise P/E" that is based on the expected value of new and profitable business opportunities. This relationship is illustrated as follows:
Franchise P/E = Observed P/E - Base P/E
Where the Base P/E equals the reciprocal of the market discount rate. For example, if the market discount rate is 12.5%, the base P/E would be equal to (1 /
12.5%) = 8.
In this example, all the necessary information has been provided, and the calculation of the Franchise P/E is as follows:
Franchise P/E = (14.25 - 8) = 6.25