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Expert-verified Found in: Page 440 ### Essentials Of Investments

Book edition 9th
Author(s) Zvi Bodie, Alex Kane, Alan Marcus, Alan J. Marcus
Pages 748 pages
ISBN 9780078034695

# 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 equity25%Industry beta1.2Government bond yield6%Equity risk premium5%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 factorsCountry ACountry BForecast growth in real GDP5%2%Government bond yield10%6%Equity risk premium5%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.

a. 30.0

b. (i) Yes (ii) Yes (iii) Yes

See the step by step solution

## Step 1: Calculation of estimated industry P/E ‘a’

gind =ROE X retention rate = 0.25 x 0.40 = 0.10

rind = government bond yield + ( industry beta x equity risk premium)

= 0.06 + (1.2 x 0.05)

= 0.12

Therefore

P0/P1 = Payout ratio / r – g

= 0.60 / (0.12 – 0.10)

= 30.0

## Step 2: Explanation on P/E ratios ‘b’

(i) Forecast growth in real GDP would cause P/E ratio to be higher for country A. This would imply higher earnings growth and a higher P/E

(ii) The higher P/E ratio for country B would be caused by government bond yield. A lower government bond yield would mean low risk free rate and higher P/E

(iii) The higher P/E ratio for country B would be caused by equity risk premium. A lower equity risk premium would mean lower required return and a higher P/E. ### Want to see more solutions like these? 