CHAPTER 12:

Problem 4: 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.

(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.

Problem 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

ROE0 0.11 0.13 0.15

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

(b) Assuming tha the S&P Industrial Index at the beginning of the year was priced at 2050 compute your estimated rate of return under the three matrket based scenarios from Part a. Assuming your required rate of return is equal to the consensus, how would you weight the S&P Industials Index in your global portfolio.

Problem 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= 0.09

Growth Rate:

Year 1-3 9%

4-6 8%

7 and beyond 7%

(a) Assuming that the current value for the S&P Industruials Indext 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.