604 Making Key Strategic Decisions
COMPARISON TO INDUSTRY AVERAGES
Victoria also compares ACME’s key financial ratios to peer companies. The
main differences between ACME and other companies of similar size in the
same industry are as follows:
- ACME’s liquidity is significantly less than other companies in the group.
Similar companies had a ratio of 1.6 while ACME had a current ratio of
1.0. This is likely due to ACME having a significant portion of its financ-
ing due within twelve months as opposed to longer term financing. - The average number of days in accounts payable for ACME is 48 days and
is significantly more than the peer group at 32 days. This is likely due to
the company taking longer to pay its expenses related to raw materials and
inventory than that of its peer group because of low working capital. - The times interest earned measure for ACME is significantly higher than
its peer group. The company had a measure of 7.3 as compared to its
peers at 4.0. This is likely due to ACME having a higher profit margin
than its peers. - ACME is significantly more leveraged than its peer group. Its measure of
debt to tangible worth is 1.8 as compared to its peers at 1.2. Also, the
company’s measure of fixed assets to tangible worth is 1.5 as compared to
its peers at 0.5. This assessment is related to the company having a higher
level of fixed assets as compared to its tangible worth. - ACME is more profitable than its peers. The measure of earnings before
taxes to total assets was 18%, as compared to its peers’ 12%. Additionally,
ACME’s earnings before taxes to tangible worth was 55% as compared to
its peers at 22%. This is due to ACME’s profit margin of 11%, as com-
pared to its peers at 5%.
The purpose of the this part of Victoria’s analysis is to assess the risk fac-
tors of owning this business as compared to an investment in the average peer
company. As previously discussed in this chapter, investors have options of
where to place their capital and rational investors require a higher reward (in
the form of returns) for investments with higher risks.
APPRAISAL OF FAIR MARKET VALUE
Victoria tells Bob that the shares of ACME are closely held securities and there
is no ready market for their sale. The three general approaches available for the
valuation of private business interests were discussed earlier in this chapter.
Victoria considers all relevant valuation approaches and methods and ulti-
mately relies on two approaches to estimate the value of ACME’s common
stock—a market approach and an income approach. She rejects the asset ap-
proach because the premise of value is a going concern and the company has no