Explain the Ratio Comparison Approach

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The Answer is Investment bankers consider a multiple of the forecast annual earnings of comparison firms when valuing the initial public offering (IPO)of a company's ordinary equity.Earnings are often smoothed proxies for long-run cash flows,and may work better as proxies than the current cash flow in determining the tracking portfolio.In some cases,these comparisons are based on book values or replacement values.Ratio comparison approach assumes that a new investment should sell at approximately the same ratio of price to some salient economic variable as an existing investment with an observable ratio.One of the common ratio comparison approaches is the price/earnings ratio method.The present value of the future cash flows of a project can be found by (1)obtaining the appropriate price/earnings ratio for the project from a comparison investment for which this ratio is known,and (2)multiplying the price/earnings ratio from the comparison investment by the first year's net income of the project.In a similar vein,a company should adopt a project when the ratio of its initial cost-to-earnings is lower than the price to earnings ratio of the comparison investment.

Explain the Ratio Comparison Approach

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