Accounting-Based Equity Valuation

After careful financial statement analysis, we obtain these predictions for Colin Technology:

Colin Technology’s cost of equity capital is estimated at 13%.

CHECK

(a) $7,205

(d) $8,644

Required:

a. Abnormal earnings are expected to be $0 per year after Year 7. Use the accounting-based equity valuation model to estimate Colin’s value at the beginning of Year 1.

b. Determine Colin’s PB ratio using the results in (a). Colin’s actual market-based PB ratio is 1.95. What do you conclude from this PB comparison?

c. Determine Colin’s PE ratio using the results in (a). Colin’s actual market-based PE ratio is 10. What do you conclude from this PE comparison?

d. If we expect Colin’s sales and profit margin to remain unchanged after Year 7 with a stable book value of $8,506, use the accounting-based equity valuation model to estimate Colin’s value at the beginning of Year 1.