P/E

d2rockstar

if Govt increased bond yields the effect on P/E using Gordon growth is that P/E will

a. No effect
b. decrease
C. unknown

scarecrow

decrease --- RFR goes up so k-reqd up, denomintor in P/E is up. hope i am right

sameeragarwal

the answer is c. based on CAPM which is an input in GG

rf+ beta(Rm-rf)

the effect depend on the magnitude of beta for each company. Can be increase or decrease

lucasg85

yea...wats d answer....

it shud b C...

chandsingh

this is very tricky but a question cfai would love to put on.


if rfr = 5% and beta = 1.

5 + 1(10-5) = 10

if rfr +1:

6 + 1(10-6) = 10


so no effect.

if beta is higher than 1 then the new E(r) is lower and if beta is lower than 1 the new E(r) is higher.

Sportsman

Neve know how they'll argue it, but I would say B.

If rfr goes up, the FORWARD LOOKING return on the market should also go up, becaus the equity risk premium should not change. Therefore the required return on capital will go up.

I say forward looking because the immediate effect will be a drop in market prices, because the discount rate applied to future prices has gone up. However, once that price has dropped, it should grow at a faster rate off of that base.

In either case, PE has gone down. Either you say the denominator is higher and so the ratio is lower, or you note that the price has dropped and earnings haven't, so the PE is lower.

troymo

I don't agree. Regardless, there is a question that is similar to this topic in the CFAI Volume 4 page 149 #9. It was driving me crazy earlier today beccause I couldn't understand the answer, so worth checking out.

Basically they say yield curve is inverted and ST yield is used, and ask what happens to the ERP. But the answer makes no sense to me, as they invoke inflation too.