Chapter 4: Q19I (page 437)
a. MF Corp. has an ROE of 16% and a plowback ratio of 50%. If the coming year’s earnings are expected to be $2 per share, at what price will the stock sell? The market capitalization rate is 12%.
b. What price do you expect MF shares to sell for in three years?
a.$25
b. $31.49
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Peninsular Research is initiating coverage of a mature manufacturing industry. John Jones, CFA, head of the research department, gathered the following fundamental industry and market data to help in his analysis:
Forecast Industry earnings retention rate | 40% |
Forecast industry returns on equity | 25% |
Industry beta | 1.2 |
Government bond yield | 6% |
Equity risk premium | 5% |
a. Compute the price-to-earnings (P0 / E1) ratio for the industry based on this fundamental data.
b. Jones wants to analyze how fundamental P/E ratios might differ among countries. He gathered the following economic and market data:
Fundamental factors | Country A | Country B |
Forecast growth in real GDP | 5% | 2% |
Government bond yield | 10% | 6% |
Equity risk premium | 5% | 4% |
Determine whether each of these fundamental factors would cause P/E ratios to be generally higher for Country A or higher for Country B.
Even Better Products has come out with a new and improved product. As a result, the firm projects an ROE of 20%, and it will maintain a plowback ratio of .30. Its earnings this year will be $2 per share. Investors expect a 12% rate of return on the stock.
a. At what price and P/E ratio would you expect the firm to sell?
b. What is the present value of growth opportunities?
c. What would be the P/E ratio and the present value of growth opportunities if the firm planned to reinvest only 20% of its earnings?
The Crusty Pie Co., which specializes in apple turnovers, has a return on sales higher than the industry average, yet its ROA is the same as the industry average. How can you explain this?
Which one of the following firms would be described as having below-average sensitivity to the state of the economy?
a. An asset play firm
b. A cyclical firm
c. A defensive firm
d. A stalwart firm
What are the differences between bottom-up and top-down approaches to security valuation? What are the advantages of a top-down approach?
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