Note: show all steps for your calculations. Rounding to 2 decimals should only
be done in the final step.
Question 1 (9 marks)
Read the scenario below and answer the questions that follow:
You are an analyst, and your manager has recently asked you to help her with
a client query. The client wants to know about the valuation method best
suited for comparing companies in an industry that have the following
characteristics:
• Those competing across the globe.
• Those for which the operating environment in the industry is currently
at a cyclical low, with many of them reporting losses.
Your manager has asked you to evaluate the following ratios in conjunction
with the information provided above:
• P/E
• EV/S
• P/B.
Your manager has also provided you with selected financial information for
Company D:

Company D (R’ millions) unless specified otherwise
Total assets 10 000
EBIT 2 250
Tax rate 28%
Cost of debt 8%
Cost of equity 15%
Share price R75.74
Book value per share R45.70
Company D finances 35% of its assets with debt and the rest with equity.
You further estimate Company D’s long term sustainable ROE to be 17% and
its long-term sustainable growth rate to be 2.5%.
Required:
1.1 Determine the valuation ratio which is most appropriate for comparing
companies in the industry and provide a reason for your answer. (2)
1.2 Calculate the residual income for Company D. (4)
1.3 Use the single-stage residual income model to calculate the intrinsic
value for Company D. Comment on the valuation. (2)
1.4 Calculate the justified price-to-book ratio for Company D. (1)