This document contains practice questions and solutions for tutorials on understanding financial reports and market-based valuation. The first question discusses whether using industry or peer group averages as benchmarks is logically flawed, as some companies will have ratios above and below the average, implying mispricing. The second question provides analysis of a company called Measure Ltd compared to peers on various valuation metrics like P/E, PEG, P/B. It finds Measure is undervalued based on fundamental ratios. The third question calculates the share value for a company with given dividend per share, retention ratio, return on equity and required return, showing the first valuation model based on these factors.

1. TUTORIAL 4: UNDERSTANDING FINANCIAL REPORTS & MARKET BASED VALUATION
Study Guide Chapter 2 & 6
DISCUSSION QUESTIONS
Q1 Theoretically no, the use of an industry and peer group average as a benchmark is logically
flawed. The average P/E will mean that by definition some firms included in the computation will
have ratios greater and some firms lower than the averagewhich, by implication means that each
firm is mispriced. How, therefore can the average P/E for a group of mispriced companies
represent the ‘true’ benchmark?
PROBLEMS
Q1. Share buy-backs
a) What is the expected EPS for 2016 if the buy-back does not go ahead.
𝐸𝑃𝑆2016 = 1.6595 (16.4%) = 𝟐𝟕.𝟐𝒄 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒
ROE = 16.4% from Tute 3
b) If shares are currently trading at $4.21 what is the expected EPS for 2016 given that the
buy-back will go ahead?
𝐸𝑃𝑆𝑡+1 =
𝐵0.𝑅𝑂𝐸𝑡+1 − 𝑒′
𝑛 − 𝑚
=
836.4 (16.4%) − 10% (504)(4.21)2%
90% (504)
=
137.17 − 4.24
453.6
= 𝟐𝟗.𝟑𝒄 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒
Where e’ = m.P.roe
Therefore the buy-back has improved EPS from 27.2c
Note: EPSbb > EPS providing that:
𝑛
𝑚
<
𝐸𝑡+1
𝑒′
Since n /m = 10 and
𝐵0.𝑅𝑂𝐸𝑡+1
𝑚.𝑃.𝑟𝑜𝑒
= 137.17 /4.24 = 32.35
Therefore 10 < 32.35 and EPS should increase.
Are non-selling shareholders better off?
Yes, since EPS is expected to increase and other things being equal, we can expect ROE to
increase- which makes sense because resources have been diverted away from surplus cash
holding which were only earnings interest after-tax of 2%.
Are selling shareholders better off?

2. This is more difficult to say. On the surface of it we would say that they are worse off however, if
the market can see the expected improvement in ROE from the buy-back then there may be a
positive reaction to the announcement, which means that selling shareholders will get more for
their shares. This in turn would suggest the cost of the buy-back will be more and therefore the
positive impact on ROE will be lower so that selling and non-selling shareholders are indifferent.
Q2 a) & b)
Peer Group
Measure X Ltd Alpha Beta Delta Average
EPS 1.50 1.20 2.50 4
P0/E0
Trailing
5.33 4.58 6.0 5.625 5.40 Undervalued
$8.10
EPS1 0.75 0.48 3.00 2.70
P0/E1
Leading
10.67 11.46 5.0 8.33 8.26 Overvalued
$6.195
g (b.ROE) 7.5% 3.6 10 3.75
PEG 0.71 1.27 0.60 1.50 1.123 Undervalued
$12.63
Fundamental
P0/E0 Trailing
21.5 Undervalued
$32.25
Fundamental
P0/E1 Leading
20.0 Undervalued
$15.00
B0 5.00 4.00 12.00 18.00
P0/B0 1.60 1.38 1.25 1.25 1.29 Overvalued
$6.45
Fundamental
P0/B0
3.0 Undervalued
$15.00
Supporting calculations
Fundamental P0/E0
(1 − 𝑏)(1+ 𝑔)
𝑟 − 𝑔
=
(1 − 0.5)(1.075)
. 10 − .075
= 21.50
Fundamental P0/E1
(1 − 𝑏)
𝑟 − 𝑔
=
1 − 0.5
. 10 − .075
= 20.0
Fundamental P0/B0
𝑅𝑂𝐸 − 𝑔
𝑟 − 𝑔
=
0.15 − .075
. 10 − .075
= 3.0

3. 𝑆𝑖𝑛𝑐𝑒 𝑃𝐸𝐺 𝑏𝑒𝑛𝑐ℎ𝑚𝑎𝑟𝑘 = 1.123
𝑃
𝐸
= 1.123 𝑥 𝑔 = 1.123 𝑥 7.5 = 8.4225
𝑃 =
𝑃
𝐸
𝑥 𝐸𝑃𝑆 = 8.4225 𝑥 1.50 = $12.63
Q3. From Q5 of “tutorial 3 questions” using DPS = (1-b)EPS. Note that firstyear of growth is 2017.
Using DPS16 = $0.242
𝑉𝑆ℎ𝑎𝑟𝑒 =
0.242
1.1
+
0.242 (1.0182)[1 − (
1.0182
1.1
)
4
]
. 1 − .0182
1
(1.1)
+
0.242 (1.0182)4
(1.03)
. 1 − .03
1
(1.1)5
= 0.22 + 0.7279 + 3.827 (0.6209) = $𝟑.𝟑𝟐
This model represents our first valuation model based on retention ratio, ROE & ROC