1. LeverCo is financed entirely by equity. The company generates operating profit equal to $80 million. LeverCo currently trades at an equity value of $900 million. At a tax rate of 25 percent, what is the price-to-earnings multiple for LeverCo? New management decides to increase leverage through a share repurchase. The company issues $400 million in bonds to retire $400 million in equity.
If the bonds pay interest at 5 percent, what is the company's new price-to-earnings ratio? Could you predict the direction the P/E ratio would move without performing this calculation?
2. What are the limitations of using enterprise-value-to-revenues multiples? When are they useful?