effect of currency appreciation on P/E relative, currency, customers, completely, understand

dmrktrading

Q#16 CFAI EOC Reading 36, Page 206

Consider French Company that exports French goods to US. What effect will a sudden appreciation in euro relative to dollar have on P/E ration of the French company. Discuss the effect when company is unable to completely pass through the euro appreciation to its customers.

Answer is P/E goes down...

I don't understand this... If company cannot pass through the appreciation to its customers in US, that means that the company is incurring losses by selling more expensive goods at historical costs.... thus the Earnings must fall.. unless Price falls more than Earnings how can P/E go down.. whats the logic behind this? Thanks.

ap0258

Please Ignore this..
I must use the same logic as Inflation. If inflation is high and isn't pass through to customers, the P/E falls.
Similarly if currency appreciation is not passed through the P/E must fall.. I guess that means that Price falls more than earnings.

jarobi04

Note that the French firm earns its revenue in USD. Euro appreciation ==> USD depreciation ==> higher USD inflation


Using the expression

P/E = 1 / (real rate + (1 - w) i)

and given that the firm is not able to pass 100% inflation to its customer, the denominator increases with inflation resulting in lower P/E.



Edited 2 time(s). Last edit at Tuesday, May 4, 2010 at 04:25AM by CFASniper.