Currently, the dividend-payout ratio (D/E) for the aggregate market is 60 percent, the required return (k) is 11 percent, and the expected growth rate for dividends (g) is 5 percent.

a. Compute the current earnings multiplier.

b. You expect the D/E payout ratio to decline to 50 percent, but you assume there will be no other changes. What will be the P/E?

c. Starting with the initial conditions, you expect the dividend-payout ratio to be constant, the rate of inflation to increase by 3 percent, and the growth rate to increase by 2 percent. Compute the expected P/E.

d. Starting with the initial conditions, you expect the dividend-payout ratio to be constant, the rate of inflation to decline by 3 percent, and the growth rate to decline by 1 percent. Compute the expected P/E.

QUESTION 7

Given the three EPS estimates in Problem 6, you are also given the following estimates related to the market earnings multiple:

PESSIMISTIC CONSENSUS OPTIMISTIC

D/E 0.65 0.55 0.45

Nominal RFR 0.10 0.09 0.08

Risk Premium 0.05 0.04 0.03

ROE 0.11 0.13 0.015

a. Based on the three EPS and P/E estimates, compute the high, low, and consensus intrinsic market value for the S&P Industrials Index in 2013.

b. Assuming that the S&P Industrials Index at the beginning of the year was priced at 2,050, compute your estimated rate of return under the three scenarios from Part a. Assuming your required rate of return is equal to the consensus, how would you weight the S&P Industrials Index in your global portfolio?

QUESTION 8

You are analyzing the U.S. equity market based upon the S&P Industrials Index and using the present value of free cash flow to equity technique. Your inputs are as follows:

Beginning FCFE: $80

K = 0.90

Growth Rate

Year 1 – 3 9%

4 – 6 8%

7 and beyond 7%

a. Assuming that the current value for the S&P Industrials Index is 2,050, would you underweight, overweight, or market weight the U.S. equity market?

b. Assume that there is a 1 percent increase in the rate of inflation—what would be the market’s value, and how would you weight the U.S. market? State your assumptions.

CHAPER 13

QUESTION 4

Evaluate your industry in terms of the five factors that determine an industry’s intensity of competition. Based on this analysis, what are your expectations about the industry’s profitability in the short run (1 or 2 years) and the long run (5 to 10 years)?

QUESTION 5

Using Standard and Poor’s Analysts’ Handbook or another source, plot the latest 10-year history of the operating profit margin for the S&P Industrials Index or another aggregate market series versus an industry of your choice. Is there a positive, negative, or zero correlation?

QUESTION 7

Prepare a table listing the variables that influence the earnings multiplier for your chosen industry and the market index series for the most recent 10 years.

a. Do the average dividend-payout ratios for your industry and the market index differ? How should the dividend payout influence the difference between the multipliers?

b. Based on the fundamental factors, would you expect the risk for this industry to differ from that for the market? In what direction, and why? Calculate the industry beta using monthly data for five years. Based on the fundamental factors and the computed systematic risk, how does this industry’s risk compare to the market? What effect will this difference in risk have on the industry multiplier relative to the market multiplier?

c. Analyze and discuss the different components of growth (retention rate, total asset turnover, total assets/equity, and profit margin) for your chosen industry and a market index during the most recent 10 years. Based on this analysis, how would you expect the growth rate for your industry to compare with the growth rate for the market index? How would this difference in expected growth affect the multiplier

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