SD17-PE RATIOS AND EARNINGS GROWTH

SD17-PE RATIOS AND EARNINGS GROWTH - CHAPTER 17 PE RATIOS...

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CHAPTER 17 PE RATIOS AND EARNINGS GROWTH LEARNING OBJECTIVES 1. How expected earnings growth affects price/earnings ratios. 2. Why we distinguish between supernormal and long-term growth rates. 3. How to use the price/earnings to growth ratio to adjust for supernormal growth differences. TRUE/FALSE QUESTIONS 1. When the PE ratio is used in a multiples-based valuation, earnings is the value driver. (easy, L.O. 1, Section 1, true) 2. One of the most influential factors on the PE ratio is stock market volatility. (moderate, L.O. 1, Section 1, false) 3. The analyst must assume that earnings and cash flow are equal to isolate the effect of expected earnings growth on the PE ratio. (moderate, L.O. 1, Section 1, true) 4. There are only a finite number of variations in earnings growth patterns. (moderate, L.O. 2, Section 1, false) 5. Failures to closely match on expected earnings growth or adjust for the effects of differences in expected earnings growth on the PE ratio in some way will result in a potentially large valuation error. (moderate, L.O. 2, Section 1, true) 6. It can be graphically shown that the PE ratio changes little with varying degrees of supernormal earnings growth expectations. (difficult, L.O. 2, Section 1, false) 7. If a company being valued that has an 20% expected supernormal growth rate is compared with a firm that has a 30% expected supernormal growth rate, a significant valuation error will occur. (difficult, L.O. 2, Section 1, true) 8. Because the supernormal growth rate affects the PE ratio, the analyst must control for it in any PE analysis. (moderate, L.O. 3, Section 2, true) 9. One way analysts attempt to achieve comparability is to match on industry; however, there can be a wide range of growth expectations across firms within the same industry. (moderate, L.O. 3, Section 2, true) 10. A firm that invests heavily in research and development may have lower current earnings but will likely have higher earnings growth expectations. (moderate, L.O. 3, Section 2, true) 11. With the simple PE approach, the analyst does not estimate growth rates of the two firms because it is explicitly assumed that the two firms’ growth rates are the same. (moderate, L.O. 3, Section 2, false) 12. The PEG ratio will be useful for valuing otherwise comparable firms with different sustainable growth rates as long as it is roughly constant across the different values of supernormal growth. 115
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(moderate, L.O. 3, Section 2, false) 13. The PEG ratio is more accurate then the PE ratio in valuing low-growth firms. (easy, L.O. 3, Section 2, false) 14. Although many analysts use the PEG ratio for the valuation of comparable firms, they do not define the ratio in a consistent way.
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This note was uploaded on 11/22/2010 for the course CAC BSA taught by Professor Kairus during the Spring '10 term at Korea University.

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SD17-PE RATIOS AND EARNINGS GROWTH - CHAPTER 17 PE RATIOS...

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