FINANCE Investment Analysis and Portfolio Management CHAPTER 14 QUESTION ANS PROBLEM
1 Give an example of a growth company and discuss why you identify it as such. Based on its P/E, do you think it is a growth stock? Explain.
2. Give an example of a cyclical stock and discuss why you have designated it as such. Is it issued by a cyclical company?
3. A biotechnology firm is growing at a compound rate of over 21 percent a year.(Its ROE is over 30 percent, and it retains about 70 percent of its earnings.)The stock of this company is priced at about 65 times next year's earnings. Discuss whether you consider this a growth company and/or a growth stock.
8. Under what conditions would you use a two-or three-stage cash flow model rather than the constant-growth model?
9. What is the rationale for using the price/book value ratio as a measure of relative value?
10. What would you look for to justify a price/book value ratio of 3.0? What would you expect to be the characteristics of a firm with a P/BV ratio of 0.6?
11. Why has the price/cash flow ratio become a popular measure of relative value during the recent past? What factors would help explain a difference in this ratio for two firms?
12. Assume that you uncover two stocks with substantially different price/sales ratios (e.g.,0.5 versus 2.5). Discuss the factors that might explain the difference.
13. Specify the major components for the calculation of economic value added and describe what a positive EV A signifies.
14. Discuss why you would want to use EV A return on capital rather than absolute EV A to compare two companies or to evaluate a firm's performance over time.
15. Differentiate between EV A and MV A and discuss the relatively weak relationship between these two measures of performance. Is this relationship surprising to you? Explain.
16. Discuss the two factors that determine the franchise value of a firm. Assuming a firm has a base cost of equity of 1l percent and does not have a franchise value, what will be its P/E?
17. You are told that a company retains 80 percent of its earnings, and its earnings are growing at a rate of about 8 percent a year versus an average growth rate of 6 percent for all firms. Discuss whether you would consider this a growth company.
18. It is contended by some that in a completely competitive economy, there would never be a true growth company. Discuss the reasoning behind this contention.
19. Why is it not feasible to use the dividend discount model in the valuation of true growth companies?
20. Discuss the major assumptions of the growth duration model. Why could these assumptions present a problem?
21. You are told that a growth company has a P/E ratio of 13 times and a growth rate of 15 percent compared to the aggregate market, which has a growth rate of 8 percent and a P/E ratio of 16 times. What does this comparison imply regarding the growth company? What else do you need to know to properly compare the growth company to the aggregate market?
22. Given the alternative companies described in the chapter (negative growth, simple growth, dynamic growth), indicate what your label would be for Walgreens. Justify your label.
23. Indicate and justify a growth label for General Motors.
PROBLEMS
3. Given Hitech's beta of 1.75 and a risk free rate of 7 percent, what is the expected rate of return, assuming
6. Lauren Industries has an 18 percent annual growth rate compared to the market rate of 8 percent. If the market multiple is 18,determine P/E ratios for Lauren Industries, assuming its beta is 1.0 and you feel it can maintain its superior growth rate for
a. the next 10 years
b. the next 5 years
7. You are given the following information about two computer software firms and the S&P Industrials Company A; Company B; S&P Industrials
P/E ratio----30.0; 27.0; 18.0
Expected annual growth rate----0.18; 0.15; 0.07
Dividend yield----0.00; 0.01; 0.02
a. Compute the growth duration of each company stock relative to the S&P Industrials.
b. Compute the growth duration of Company A relative to Company B.
c. Given these growth durations, what determines your investment decision?
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