Use the following information to answers questions 5 - 11

Trey Chunn is updating research reports on two well-established consumer companies before first quarter 2011 earnings reports are released. His supervisor, Dr. Okafor, has asked Trey to use market-based valuations when updating the reports.

Delite Beverage is a manufacturer and distributor of soft drinks and recently acquired a major water bottling company in order to offer a broader product line. The acquisition will have a significant impact on Delites future results.

You Fix It is a United States retail distributor of products for home improvement, primarily for those consumers who choose to do the work themselves. The home improvement industry is cyclical; the industry was adversely affected by the recent downturn in the economy, the level of foreclosures, and slow home sales. Although sales and earnings at You Fix It weakened, same store sales are beginning to improve as consumers undertake more home improvement projects. Poor performing stores were closed, resulting in significant restructuring charges in 2010.

Before approving Treys work, Dr. Okafor wants to discuss the calculations and choices of ratios used in the valuation of Delite and You Fix It. The data used by Cannan in his analysis is summarized in Exhibit 1.

EXHIBIT 1

Select Financial Data for Delite Beverage and You Fix It.
	Delite Beverage	You Fix It
2010 Earnings per share (EPS)	$3.44	$1.77
2011 estimated EPS	$3.50	$1.99
Book value per share end of year	$62.05	$11.64
Current share price	$65.50	$37.23
Sales (billions)	$32.13	$67.44
Free cash flow per share	$2.68	$0.21
Shares outstanding end of year	2,322,034,000	1,638,821,000

Trey advises Dr. Okafor that he is considering three different approaches to value the shares of You Fix It:

• Approach 1 Price-to-book (P/B) ratio
• Approach 2 Price-to-earnings (P/E) ratio using trailing earnings
• Approach 3 Price-to-earnings ratio using normalized earnings

Trey tells Dr. Okafor that he calculated the price-to-sales ratio (P/S) for You Fix It, but chose not to use it in the valuation of the shares. Trey states to Dr. Okafor that it is more appropriate to use the P/E ratio rather than the P/S ratio because:

• Reason 1 Earnings are more stable than sales.
• Reason 2 Earnings are less easily manipulated than sales.
• Reason 3 The P/E ratio reflects financial leverage whereas the P/S ratio does not.

Trey also informs Dr. Okafor that he did not use a price-to-cash flow multiple in valuing the shares of Delite or You Fix It. The reason is that he could not identify a cash flow measure that would both account for working capital and non-cash revenues, and also be after interest expense and thus not be mismatched with share price. Dr. Okafor advises Trey that such a cash flow measure does exist.

Dr. Okafor provides Trey with financial data on three close competitors as well as the overall beverage sector, which includes other competitors, in Exhibit 2. He asks Trey to determine, based on the price-to-earnings growth (PEG) ratio, whether Delite shares are overvalued, fairly valued, or undervalued.

EXHIBIT 2 Beverage Sector Data

	Forward P/E	Earnings Growth
Delite		12.41%
Fresh Iced Tea Company	16.59	9.52%
Nonutter Soda	15.64	11.94%
Tasty Root Beer	44.10	20%
Beverage Sector Average	16.40	10.80%

After providing Dr. Okafor his answer, Trey is concerned about the inclusion of Tasty RootBeer in the comparables analysis. Specifically, Trey asks Dr. Okafor:

I feel we should mitigate the effect of large outliers, but not the impact of small outliers (i.e., those close to zero), when calculating the beverage sector P/E. What measure of central tendency would you suggest we use to address this concern?

Dr. Okafor requests that Trey incorporate their discussion points before submitting the reports for final approval.

5. Based on the information in Exhibit 1, compute the most appropriate price-to-earnings ratio to use in the valuation of Delite

6. Based upon the information in Exhibit 1, compute the price-to-sales ratio for You Fix It

7. Which valuation approach would be most appropriate in valuing shares of You Fix It? Make sure to provide supporting arguments

A. Approach 1

B. Approach 2

C. Approach 3

8. Treys preference to use the P/E ratio over the P/S ratio is best supported by:

Make sure to provide supporting arguments

A. Reason 1

B. Reason 2

C. Reason 3

9. The cash flow measure that Dr. Okafor would most likely recommend to address Treys concern is: (Make sure to provide supporting arguments)

A. free cash flow to equity.

B. earnings plus non-cash charges.

C. earnings before interest, tax, depreciation, and amortization

10. Based upon the information in Exhibits 1 and 2, Trey would most likely conclude that Delites shares are: (Make sure to provide supporting arguments)

A. overvalued.

B. undervalued.

C. fairly valued.

11. The measure of central tendency that Ritter will most likely recommend is the: (Make sure to provide supporting arguments)

A. median.

B. harmonic mean.

C. arithmetic mean.