The following information is derived from the latest financial statements of Adorn Co.

Adorn Co is listed on a stock exchange and is engaged in house-building (all amounts are in

thousands of pounds).

Sales Earnings Book value Market value

Adorn Co 86,000 7,300 39,000 117,000

Chroma Co is also engaged in house-building. It is privately owned and reported the following numbers for the latest period (all amounts are in thousands of pounds).

Sales 43,000

Earnings 4,100

Book Value 19,000

The managing director of Chroma Co is considering an initial public offer of the shares and would like to have an indication of the value of the companys common shares.

There is no debt in either Adorn Co or Chroma Co.

Required:

(a) Compute three relevant price comparable ratios for Adorn Co.

(b) Apply the three ratios computed in (a) above to the relevant numbers for Chroma Co and put forward an indicative estimate of the total market value of Chroma Co. State any assumptions.

(c) Critically evaluate the advantages and limitations of the use of price comparable ratios in arriving at a valuation of common shares and state which, in your opinion, is the most relevant ratio in valuing Chroma Co. (20 marks)

(d) The price/earnings ratio is one of the mostly widely used metrics to compare performance and future prospects of two companies. Critically evaluate the price earnings ratio and conclude with reasons whether you think it is a useful metric.

(10 marks)