(Adapted from 2001 CFA Level I1 exam) Peninsular Research is initiating coverage of a mature manufacturing industry. John Jones, CFA, head of the research department, gathers the information given in Exhibit 20-1 to help in his analysis.
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EXHIBIT 20-1 Fundamental industry and Market Data |
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Forecasted industry earnings retention rate |
40% |
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Forecasted industry return on equity |
25% |
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Industry beta |
1.2 |
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Government bond yield |
6% |
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Equity risk premium |
5% |
A. Compute the price to earnings (Po/EI) ratio for the industry based on the fundamental data in Exhibit 20-1. Show your work. Jones wants to analyze how fundamental PIES might differ among countries. He gathers the data given in Exhibit 20-2:
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EXHIBIT 20-2 Economic and Market Data |
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Fundamental Factors |
Country A |
Country B |
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Forecasted growth in real gross domestic product |
5% |
2% |
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Government bond yield |
10% |
6% |
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Equity risk premium |
5% |
4% |
B. Determine whether each of the fundamental factors in Exhibit 20-2 would cause PIES to be generally higher for Country A or higher for Country B. Justify each of your conclusions with one reason. Note: Consider each fundamental factor in isolation, with all else remaining equal.