Willa Dowd collected the following information for a small-cap firm that she is evaluating:
Stock price per share $20.50
Expected sales $920 million
Operating expenses (excluding interest) $405 million
Depreciation amortization $44 million
Return on equity (ROE) 12%
Shares outstanding 31 million
Common shareholders' equity $380 million
The Price/Cash Flow (P/CF) for the small-cap firm is closest to:
Click on the arrows to vote for the correct answer
A. B. C.A
To calculate the Price/Cash Flow (P/CF) ratio, we need to determine the cash flow from operations.
The formula to calculate cash flow from operations is:
Cash Flow from Operations = Net Income + Depreciation/Amortization
In this case, we don't have the net income information, but we have the Return on Equity (ROE), which can help us estimate the net income.
Return on Equity (ROE) is calculated as:
ROE = Net Income / Common Shareholders' Equity
From the given information, we know the ROE is 12%, and the Common Shareholders' Equity is $380 million. Rearranging the formula, we can estimate the net income as:
Net Income = ROE * Common Shareholders' Equity
Net Income = 0.12 * $380 million Net Income = $45.6 million
Now, let's calculate the cash flow from operations:
Cash Flow from Operations = Net Income + Depreciation/Amortization Cash Flow from Operations = $45.6 million + $44 million Cash Flow from Operations = $89.6 million
Next, we can calculate the P/CF ratio:
P/CF = Stock Price per Share / Cash Flow from Operations P/CF = $20.50 / $89.6 million
To convert million to per share, we divide by the number of shares outstanding:
P/CF = $20.50 / ($89.6 million / 31 million) P/CF = $20.50 / $2.89
Finally, we can calculate the P/CF ratio:
P/CF ≈ 7.1 (rounded to one decimal place)
Therefore, the closest P/CF ratio for the small-cap firm is 7.1, which corresponds to option A.