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Herb McClain tells Cammy Oren that Kline Industries’ expected dividend growth rate is 4.0%, ROE is 14%, and required return on equity (r) is 10%. Based on a justified P/B ratio compared to a P/B ratio (based on market price per share) of 1.55, Kline Industries is most likely:
A)
undervalued.
B)
overvalued.
C)
correctly valued.



Justified P/B = (ROE − g) / (r − g). When the expected dividend growth is 4.0%, the justified P/B = (0.14 − 0.04) / (0.10 − 0.04) = 1.67. This is greater than the P/B (at market) of 1.55.

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An analyst is preparing a presentation on “Interpreting PE ratios” and has the following data:
Portfolio %Stock PE
Stock AAA60%10
Stock BBB40%15

Which of the following is the most appropriate measure for calculating the portfolio P/E?
A)
Geometric mean of the P/E’s.
B)
Arithmetic average of the P/E’s.
C)
Weighted harmonic mean of the P/E’s.



The weighted harmonic mean of the 10 and 15 will give the result closest to the portfolio earnings divided by the portfolio value.

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An analyst is calculating the weighted harmonic mean P/E ratio of a 2-stock portfolio. Stocks AAA and BBB have prices of $12 and $15, respectively, and EPS of $1 and $2, respectively. Which of the following is the weighted harmonic mean P/E of the portfolio closest to?
A)
9.00
B)
9.23
C)
9.75



The weighted harmonic mean is 1/[(12/27)(1/12) + (15/27)(2/15)] = 27/3 = 9.00 The weighted harmonic mean of the individual stocks P/Es is the best measure of the P/E for a portfolio of stocks.

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An analyst is preparing a presentation on “Interpreting PE ratios” and has the following data:
Portfolio %Stock PE
Stock AAA60%10
Stock BBB40%15

Which of the following is closest to the weighted harmonic mean of these two PE ratios?
A)
12.49.
B)
11.98.
C)
11.54.



The weighted harmonic mean of the two PE ratios is a harmonic mean which is weighted by the portfolio weights.
1/[(0.60 × 1/10) + (0.40 × 1/15)] = 11.54

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