QUESTIONS AND SHORT PROBLEMS

In the problems following, use an equity risk premium of 5.5 percent if none is specified.

1. Longs Drug Stores, a large U.S. drugstore chain operating primarily in Northern California, had sales per share of $122 in 1993, on which it reported earnings per share of $2.45 and paid a dividend per share of $1.12. The company is expected to grow 6% in the long term, and has a beta of 0.90. The current T-bond rate is 7%, and the market risk premium is 5.5%.
   1. Estimate the appropriate price-sales multiple for Longs Drug.
   2. The stock is currently trading for $34 per share. Assuming the growth rate is estimated correctly, what would the profit margin need to be to justify this price per share?
2. You are examining the wide differences in price-sales ratios that you can observe among firms in the retail store industry, and trying to come up with a rationale to explain these differences:

   

   1. There are two companies that sell for more than revenues, the Bombay Company and Wal-Mart. Why?
   2. What is the variable that is most highly correlated with price-sales ratios?
   3. Which of these companies is most likely to be over or undervalued? How did you arrive at this judgment?