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14.18 Interpreting Market-to-Book Ratios. Exhibit 14.10 presents data on market-to-book (MB) ratios, ROCE, the cost of equity capital, and price-earnings (PE) ratios for seven pharmaceutical companies. (Note that PE ratios for these rms typically fall in the 3035range.) Exhibit 14.10 also provides historical data on the ve-year average rate of growth in earnings and dividend payout ratios for each rm. The data on excess earnings years represent the number of years that each rm would need to earn a rate of return on common shareholders equity (ROCE) equal to that in Exhibit 14.10 in order to produce value-to-book ratios that equal the market-to-book ratios shown. For example, Bristol-Myers Squibb would need to earn an ROCE of 48.9% for 58.3 years in order for the present value of the excess earnings over the cost of equity capital to produce a value-to-book ratio that matches the market-to-book ratio of 13.9

REQUIRED

Assume that market share prices for each rm are reasonably efcient. That is, do not simply assume that the market has over- or undervalued these rms. Considering the theoretical determinants of the market-to-book ratio, discuss the likely reasons for the relative ordering of these seven companies on their market-to -book ratios

Exhibit 14.10 Selected Data for Pharmaceutical Companies (Problem 14.18) Cost of Dividend Equity Payout MB ROCE Capital Ratio PE Excess Growth in Earnings Earnings Years Company Bristol-Myers Squibb Warner-Lambert Eli Lilly Pfizer Abbott Laboratories Merck Wyeth 13.9 13.0 12.4 11.2 10.4 10.3 6.9 0.489 0.350 0.281 0.350 0.428 0.331 0.340 0.134 0.133 0.155 0.143 0.113 0.154 0.138 0.77 0.48 0.42 0.43 0.39 0.46 0.51 32.4 42.7 49.3 40.4 26.9 31.8 25.0 0.068 0.051 0.110 0.152 0.116 0.130 0.065 58.3 32.2 89.8 27.8 13.5 41.9 24.6