Price/Book

[ditchdigger2CFA]

Falcon Financial Group is considering the purchase of Company A or Company B based on a low price-to-book investment strategy that also considers differences in solvency. Selected financial data for both firms, as of December 31, 20X7, follows:

in millions, except per-share data
Company A
Company B

Current assets
$3,000
$5,500

Fixed assets
$5,700
$5,500

Total debt
$2,700
$3,500

Common equity
$6,000
$7,500

Outstanding shares
500
750

Market price per share
$26.00
$22.50


The firms� financial statement footnotes contain the following:

Company A values its inventory using the first in, first out (FIFO) method.
Company B�s inventory is based on the last in, first out (LIFO) method. Had Company B used FIFO, its inventory would have been $700 million higher.
Company A leases its manufacturing plant. The remaining operating lease payments total $1,600 million. Discounted at 10%, the present value of the remaining payments is $1,000 million.

Company B owns its manufacturing plant.
To make the firms financials ratios comparable, calculate the adjusted price-to-book ratios for Company A and Company B.



Company A
Company B



A) $2.17
$2.81



B) $2.17
$2.06



C) $1.63
$2.06



D) $1.63
$2.81

 

[map1]

Is it B?

 

[Mihaz]

I would say b also.
I only added 700 to equity for company b and that is it. Operating lease is not a part of equity. We should rise debt for it, but it is not the case here....

 

[map1]

Adjustments necessary:

For ratios that are balance sheet related, adjustments to FIFO are needed. For ratios that are income related, adjustments to LIFO are needed.
As such, an adjustment to company B's inventory is needed, +700, therefore CA of company B is 6,200

For company A, both a long term asset and a liability (debt) in amount equal to the PV of the operating lease payments are needed, so actually both sides of the accounting equation increase by the same amount (+1000). Therefore:

Fixed assets of Company A=6,700, Total Debt of Company A=3,700

Recalculate Common equity:

Company A = 3,000+6,700-3,700=6,000, a BV of 6,000/500=12, for a P/BV=26/12=2.16
Company B = 6,200+5,500-3,500=8,200, a BV of 8,200/750=10.93, for a P/BV=22.5/10.93=2.06