CMA Study Group

 View Only

Calculating Retained Earnings - Book Value Per Share - CMA Part 2

  • 1.  Calculating Retained Earnings - Book Value Per Share - CMA Part 2

    Posted 01-20-2022 08:19 PM
    Hi All,

    Please see the question below, followed by an explanation of my confusion:

    Fact Pattern: Bull & Bear Investment Banking is working with the management of Clark, Inc., in order to take the company public in an initial public offering. Selected financial information for Clark is as follows.

    Long-term debt (8% interest rate)
    $10,000,000
    Common equity:
    Par value ($1 per share)
    3,000,000
    Additional paid-in-capital
    24,000,000
    Retained earnings
    6,000,000
    Total assets
    55,000,000
    Net income
    3,750,000
    Dividend (annual)
    1,500,000
    If public companies in Clark's industry are trading at a market to book ratio of 1.5, what is the estimated value per share of Clark?

    The correct answer is $16.50. This is arrived at by first determining the book value per share. As you know, the numerator is total common equity, or total equity less preferred equity. This would include the CS par value and APIC, $3,000,000 and $24,000,000, and the retained earnings balance of $6,000,000. My next thought was to adjust the retained earnings balance for the effect of net income and dividends, but that does not produce the correct answer. When provided with figures for dividends and net income alongside the retained earnings balance, how are we supposed to know when to adjust retained earnings vs. assume the balance is final? Thanks in advance for your help.

    ------------------------------
    Bradley Bigio
    Analyst
    Cocoa FL
    United States
    ------------------------------