Financial leverage and Implied P/E multiple without regard to an associate

Italian Company I

Accounting standard					IFRS
Method to account for its investment in the U.S. associates					Equity method
Equity interest in a company located in the U.S.					30%
The U.S. associate's accounting standard					U.S. GAAP

Selected Financial Data--Company I

In EUR millions						2009	2008	2007
Income statement
Revenue						60,229	55,137
Earnings before interest and tax						7,990	7,077
Earnings before tax						7,570	6,779
Income from associatea						354	270
Net income						6,501	5,625
Unearned revenue						7,201	5,514
Balanace Sheet
Total assets						56,396	53,111	45,597
Investment in associate						5,504	5,193
Shareholder's equity						30,371	29,595	27,881

^a Not included in EBIT or EBT.

Company I

Financial leverage = Average total assets / Average equity
Financial leverage (2009) = ((56,396+53,111)/2) / ((30,371+29,595)/2) = 54,753.5/29,983 = 1.8262

Financial leverage (2008) = ((53,111+45,597)/2) / ((29,595+27,881)/2) = 49,354/28,738 = 1.7174

Although leverage was higher in 2009, the nature of the true leverage (in 2009) was lower (than the one calculated above). This is because the increasing unearned revenue will not require an outflow of cash in the future and are, thus, less onerous than the Company I's other liabilities.

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Selected Market Capitalization Data

In millions except exchange rates					I			U.S. associate
Market cap					EUR 97,525			USD 32,330
Current exchange rate (EUR/USD)					0.70
Average exchange rate (EUR/USD)					0.73

Company I implied P/E multiple without regard to its U.S. associate
Implied value without its U.S. assosiate = Market cap (I) - Pro-rata share of associate's market cap
= 97,525 - 32,330*0.70*30% = 90,735.7

Net income without associate = 6,501 - 354 = 6,147


Implied P/E = 90,735.7/6,147 = 14.7610