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# sm13 - CHAPTER 13 STOCK MARKET ANALYSIS 1 Although...

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CHAPTER 13 STOCK MARKET ANALYSIS 1. Although corporate earnings may rise by 12 percent next year, that information by itself is not sufficient to forecast an increase in the stock market. The market level is a product of both corporate earnings and the earnings multiple. The earnings multiple must likewise be projected since it is not stable over time. 2. Student Exercise 3. The investor can improve his net profit margin estimate by working from the gross margin down to the net profit margin. By this procedure, the investor explicitly considers each major component that affects the net profit margin. This level of analysis provides insights into the components which do not behave consistently over time. Also, the gross profit margin should be easier to estimate since it has the lowest level of relative variability. 4. The effect of a decline in capacity utilization should be a decline in the aggregate profit margin, all else the same, because it will mean greater overhead and depreciation per unit of output. Also more fixed financial charges per unit. 5. The increase in hourly wages of 6 percent will, all else held equal, cause the operating margin to decrease. In addition to the estimate of the changes in the hourly wage rate, an estimate of the productivity rate change is also needed to forecast the unit labor cost change. The relationship is: % Hourly Wages - % Productivity = % Unit Labor Cost 6. 7.0- 5.0 = 2.0% increase in the unit labor cost. The unit labor cost is negatively related to the profit margin. This increase would, holding other factors constant, decrease the aggregate profit margin. Because it is a low rate of increase, the effect on the profit margin should be small. 7. 7(a). An increase in the ROE with no other changes should cause an increase in the multiple because it would imply a higher growth rate. An important question is, how was the increase in ROE accomplished? If it was due to operating factors (higher asset turnover or profit margin) it is positive. If it was due to an increase in financial leverage, there could be some offset due to an increase in the required rate of return (k).

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