ExpertEasy2 marksMultiple Choice
ACCA · Question 13 · Business Valuations
Section A
Retail giant ShopSmart is looking to acquire a smaller competitor, QuickMart. QuickMart recently reported earnings of $2.5 million. ShopSmart has a Price/Earnings (P/E) ratio of 12, while the average P/E ratio for unlisted companies in the retail sector is 8. QuickMart is an unlisted company.
Using the P/E ratio method, what is the most appropriate valuation for QuickMart?
Section A
Retail giant ShopSmart is looking to acquire a smaller competitor, QuickMart. QuickMart recently reported earnings of $2.5 million. ShopSmart has a Price/Earnings (P/E) ratio of 12, while the average P/E ratio for unlisted companies in the retail sector is 8. QuickMart is an unlisted company.
Using the P/E ratio method, what is the most appropriate valuation for QuickMart?
Answer options:
A.
$30.0 million
B.
$20.0 million
C.
$25.0 million
D.
$10.0 million
How to approach this question
Multiply the target company's earnings by the appropriate P/E ratio. For an unlisted target, use the P/E ratio of similar unlisted companies, or a discounted listed sector average.
Full Answer
B.$20.0 million✓ Correct
When valuing an unlisted company using the P/E ratio method, you should use a P/E ratio that reflects the target's status. The acquirer's P/E ratio (12) reflects a listed, highly liquid company. The unlisted sector average (8) is the appropriate multiplier. Valuation = $2,500,000 $\times$ 8 = $20,000,000.
Common mistakes
Using the acquiring company's P/E ratio, which fails to account for the lack of marketability (liquidity discount) of the unlisted target.
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