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Here are four industries and four forecasts for the macro-economy. Choose the industry that you would expect to perform best in each scenario.

Industries: housing construction, health care, gold mining, steel production.

Economic Forecasts:

Deep recession: falling inflation, falling interest rates, falling GDP.

Superheated economy: rapidly rising GDP, increasing inflation and interest rates.

Healthy expansion: rising GDP, mild inflation, low unemployment.

Stagflation: falling GDP, high inflation.

Short Answer

Expert verified

Answer

Health care (non-cyclical) : Deep recession

Steel production (Cyclical): Superheated economy

Housing construction (Cyclical but sensitive to interest rate reduction): Healthy expansion

Gold mining (countercyclical) Stagflation

Step by step solution

01

Step by Step Solution Step 1: Definition of economic recession

A period of temporary economic decline in trading and industrial activity is known as an economical recession.

02

Categorization of industries

Health care (non-cyclical) : Deep recession

Steel production (Cyclical): Superheated economy

Housing construction (Cyclical but sensitive to interest rate reduction): Healthy expansion

Gold mining (countercyclical Stagflation

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Most popular questions from this chapter

The price of imported oil fell dramatically in late 2008. What sort of macroeconomic shock would this be considered?

Use the following case in answering Problems 29 – 32:

Mary Smith, a Level II CFA candidate, was recently hired for an analyst position at the Bank of Ireland. Her first assignment is to examine the competitive strategies employed by various French wineries.

Smith’s report identifies four wineries that are the major players in the French wine industry. The key characteristics of each are cited in Table 12.6. In the body of Smith’s report, she includes a discussion of the competitive structure of the French wine industry. She notes that over the past five years, the French wine industry has not responded to changing consumer tastes. Profit margins have declined steadily, and the number of firms representing the industry has decreased from 10 to 4. It appears that participants in the French wine industry must consolidate in order to survive.

Smith’s report notes that French consumers have strong bargaining power over the industry.

She supports this conclusion with five key points, which she labels “Bargaining Power of Buyers”:

  • Many consumers are drinking more beer than wine with meals and on social occasions.
  • Increasing sales over the Internet have allowed consumers to better research the wines, read opinions from other customers, and identify which producers have the best prices.
  • The French wine industry is consolidating and consists of only 4 wineries today compared to 10 wineries five years ago.
  • More than 65% of the business for the French wine industry consists of purchases from restaurants. Restaurants typically make purchases in bulk, buying four to five cases of wine at a time.
  • The land where the soil is fertile enough to grow grapes necessary for the wine production process is scarce in France.

After completing the first draft of her report, Smith takes it to her boss, RonVanDriesen, to review. VanDriesen tells her that he is a wine connoisseur himself and often makes purchases from the South Winery. Smith tells VanDriesen, “In my report, I have classified the South Winery as a stuck-in-the-middle firm. It tries to be a cost leader by selling its wine at a price that is slightly below the other firms, but it also tries to differentiate itself from its competitors by producing wine in bottles with curved necks, which increases its cost structure. The end result is that the South Winery’s profit margin gets squeezed from both sides.” VanDriesen replies, “I have met members of the management team from the South Winery at a couple of the wine conventions I have attended. I believe that the South Winery could succeed at following

both cost leadership and a differentiation strategy if its operations were separated into distinct operating units, with each unit pursuing a different competitive strategy.” Smith makes a note to do more research on generic competitive strategies to verify VanDriesen’s assertions before publishing the final draft of her report.

If the French home currency were to greatly appreciate in value compared to the English currency, what is the likely impact on the competitive position of the East Winery?

a. Make the firm less competitive in the English market.

b. No impact, since the major market for East Winery is England, not France.

c. Make the firm more competitive in the English market.

Explain why the following statements are true/false/uncertain.

a. With all else held constant, a firm will have a higher P/E if its beta is higher.

b. P/E will tend to be higher when ROE is higher (assuming plowback is positive).

c. P/E will tend to be higher when the plowback rate is higher.

Choose an industry and identify the factors that will determine its performance in the next three years. What is your forecast for performance in that period?

Phoebe Black’s investment club wants to buy the stock of either NewSoft, Inc. or Capital Corp. In this connection, Black prepared the following table. You have been asked to help her interpret the data, based on your forecast for a healthy economy and a strong stock market over the next 12 months.

New soft Inc.

Capital Corp.

S & P 500 index

Current Prices

\(30

\)32

Industry

Computer Software

Capital Goods

P/E ratio (current)

25

14

16

P/E ration (5 yr average)

27

16

16

Price/book ratio (current)

10

3

3

Price/book ratio (5-year average)

12

4

2

beta

1.5

1.1

1.0

Dividend yield

.3%

2.7%

2.8%

a. Newsoft’s shares have higher price–earnings (P/E) and price–book value (P/B) ratios than those of Capital Corp. (The price–book ratio is the ratio of market value to book value.) Briefly discuss why the disparity in ratios may not indicate that NewSoft’s shares are overvalued relative to the shares of Capital Corp. Answer the question in terms of the two ratios, and assume that there have been no extraordinary events affecting either company.

b. Using a constant-growth dividend discount model, Black estimated the value of NewSoft to be \(28 per share and the value of Capital Corp. to be \)34 per share.

Briefly discuss weaknesses of this dividend discount model, and explain why this model may be less suitable for valuing NewSoft than for valuing Capital Corp.

c. Recommend and justify a more appropriate dividend discount model for valuing New- Soft’s common stock.

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