Market Multiples and Reverse Engineering Share Prices. In 2000, Enron enjoyed remarkable success in the capital markets. During that year, Enrons shares increased in value by 89% while the S&P index fell by 9%. At the end of 2000, Enrons shares were trading at roughly 83.00 per share and all of the sell-side analysts following Enron recommended the shares as a buy or strong buy. With 752.2 million shares outstanding, Enron had a market capitalization of $62,530 Million and was one of the largest firms (in terms of market capital) in the United States. At year-end 2000, Entons book Value of common shareholders equity was $11,470 Million.

At year-end 2000, Enron posted earnings per share of $1.19. Among sell-side analysts following Enron, the consensus forecast for earnings per share was $1.31 per share for 2001 and $1.44 per share for 2002, with 10% earnings growth expected from 2003-2005. At the time, Enron was paying dividends equivalent to roughly 40% of earnings and was expected to maintain that payout policy.

At year end 2000, Enron had a market beta of 1.7. The Risk free rate of return was 4.3% and the market risk premium was 5%.

REQUIRED

A.) Use CAPM to compute the required rate of return on common equity capital for Enron

B.) Use year-end 2000 data to compute the following ratios for Enron:

i. Market-To-Book ii. Price Earnings (using 2000 earnings per share) iii. Forward price earnings (using consensus forecast earnings per share from 2001)

C.) Reverse engineer Enrons $83 share price to solve for the implied expected return on Enron shares at year-end 2000. Do the reverse engineering under the following assumptions:

i.) Enrons market price equals value.

ii. The consensus analysts earnings per share forecasts through 2005 are reliable proxies for market expectations.

iii. Enron will maintain a 40% dividend payout rate.

iv. Beyond 2005, Enrons long-run earnings growth rate will be 3.0%. D.) What do these analyses suggest about investing in Enrons shares at a price of $83.00