Question

I am given the following problem and solution. When comparing the net sales ratios, what does this indicate about the firms? If they were to drop below 1, what would this mean?

[Relative Value Concepts Using Multiples] The WestTek privately held venture is considering the sale of the venture to an outside buyer. WestTek has net sales = $21.2 million, EBITDA = $11.1 million, net income = $2.9 million, and interest-bearing debt = $12 million. Three publicly-traded comparable firms or competitors in the industry have the following net sales, EBITDA, net income, equity value or market capitalization (stock price times number of shares of common stock outstanding), and interest-bearing debt information:

EastTek SouthTek NorthTek

Net sales $25,000,000 $37,500,000 $80,000,000

EBITDA 12,500,000 20,000,000 37,500,000

Net Income 2,500,000 3,000,000 10,000,000

Equity Value 45,000,000 60,000,000 160,000,000

Interest-bearing 15,000,000 20,000,000 40,000,000

Calculate the enterprise value to net sales ratios for each of the three competitors (EastTek, SouthTek, and NorthTek), as well as the average ratio for the competitors.

Answer 1

Net sales ratios reflect the market's valuation of a company's sales. Ratios below 1 imply a valuation less than the net sales, typically indicating problems. The enterprise value to net sales ratio and the four-firm concentration ratio are important measures for assessing firm value and market competition, respectively.

Step-by-step explanation:

When comparing the net sales ratios of firms, these ratios indicate the value the market is placing on each dollar of a company's sales. A ratio above 1 means the market is valuing the company at more than its net sales, possibly due to good profit margins, strong future growth prospects, or effective cost management. If the net sales ratio were to drop below 1, it would suggest that the market values the company at less than its net sales, which could be a sign of issues such as low profitability, poor growth prospects, or inefficiencies.

Calculating the enterprise value to net sales ratios for each of the three competitors will require adding equity value and interest-bearing debt and then dividing by net sales. This provides a measure of how much investors are willing to pay for each dollar of sales. An average ratio across competitors gives a baseline for comparison to assess relative value, which can influence decisions in potential sales or mergers. A ratio well below the average could indicate an undervalued firm, or one facing operational or industry challenges.

The four-firm concentration ratio is a measure that reflects the market share controlled by the four largest firms in an industry. This can provide insight into the level of competition and the potential impact of mergers and acquisitions on market dynamics.