Question

E3.8. Pricing Multiples: General Mills, Inc. (Medium)
General Mills, the consumer foods company, traded at 1.6 times sales in 2011. It was
reporting a net profit margin on its sales of 10.4 percent. What was its P/E ratio?
E3.9. Measuring Value Added (Medium)
a. Buying a stock. A firm is expected to pay an annual dividend of $2 per share forever.
Investors require a return of 12 percent per year to compensate for the risk of not
receiving the expected dividends. The firm's shares trade for $19 each. What is the
value added by buying a share at $19?
b. An investment within a firm. The general manager of a soccer club is considering pay-
ing $2.5 million per year for five years for a "star" player, along with a $2 million up-
front signing bonus. He expects the player to enhance gate receipts and television
advertising revenues by $3.5 million per year with no added costs. The club requires a
9 percent return on its investments. What would be the value added from the acquisi-
tion of the player?

Answer 1

Ans:- (a) In this question, it is given that General Mills, the consumer foods company, traded at 1.6 times sales in 2011 that means its Price to sales(P/S) ratio is given 1.6.  It was reporting a net profit margin on its sales of 10.4 percent that means its Earning on sales (E/S) ratio is given 10.4. we need to find P/E ratio.

P/E ratio will be given by (P/S)/(E/S) =P/S * S/E = P/E = 1.6/10.4% =15.38%

(b) In this we need to find value added by buying a share of $19.

Value-added/loss per share is calculated by the difference between the value of a share with the share price.

Therefore, we first need to find the value of share.

Value of share is given by (Dividend paid/ Rate of return) = 2/12% = 16.67

Now the Value-added/loss per share is given by (Value of share - Share Price). The price of the share is $19.

(16.67 - 19) = -2.33.

Therefore, in this case, the value is lost by $2.33 per share.

(c) In this case, the club requires a 9% return on its investment made on the soccer player. we need to find the value-added from acquisition of the players.

First, we need to find the Net amount received by the club per year.

Net amount received by the club per year will be given by (Revenue generated per year - yearly payment made)

= $3500000 - $2500000 = $1000000 = $1 million.

Now the next step is to find the present value of an annuity of the net amount generated by the club in those five years.

PV of an annuity is given by = Amount received by the club per year * ( 1- 1/(1+r)^n)/r,

where n is the number of years and r is the required rate.

= 1000000 * ( 1 - 1/(1+0.09)^5)/0.09

= 1000000 * 3.889

= 3889000 = $3.889 million.

It is given in the question that initial investment done by the club on the soccer player is $2 million.

Therefore the value added/loss from the acquisition of the player will be given by

Present Value of annuity - Initial investment by the club

= $3889000 - 2000000  = $1889000 = $1.889 million.

In this case, the value added by the club is $1.889 million.