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Question 6 (15 marks) Nash Manufacturing is a “darling” of Wall Street analysts. Its current market...

Question 6

Nash Manufacturing is a “darling” of Wall Street analysts. Its current market price is $20 per share, and its book value is $8 per share. Analysts forecast that the firm’s book value will grow by 12 percent per year indefinitely, and the cost of equity is 17 percent. (Hint: You could apply the shortcut forms of profit-based valuation asset valuation model)

1) Given these facts, what is the market’s expectation of the firm’s long-term average ROE?

2) What will be Nash Manufacturing’s stock price if the market revises its expectations of long-term average ROE to 20 percent?

3) Analysts reassess Nash Manufacturing’ future performance as follows: growth in book value increases to 14 percent per year, but the ROE of the incremental book value turns out to be 17 percent at the moment. The cost of equity remains. What is the impact on the market-to-book ratio?

4) Is there a possibility that a company with a high ROE have a low PE ratio? Please explain the reasons for your answer.

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