Reading 44: U.S. Portfolio Strategy: Seeking Value—Anato

valuation, discount, expected, maintain, function

LOS d: Indicate the impact of discount rate sensitivity in valuation models.

Q1. At a CFA society function, Robert Chan comments to Li Chiao that the expected dividend growth rate for Xanedu Industries has decreased 0.5% from 6.0% to 5.5%. Chan claims that since Xanedu will maintain their historic dividend payout ratio (g) of 40% and cost of equity (k) of 12%. Xanedu's P/E ratio will also decrease by 0.5%. Is Chan correct?

A) Yes, Xanedu's P/E ratio will increase by approximately 0.5%.

B) No, Xanedu's P/E ratio will decrease by approximately 7.8%.

C) No, Xanedu's P/E ratio will increase by approximately 7.8%.

Q2. At a CFA society function, Andrew Caza comments to Nanda Dhople that the expected dividend growth rate (g) for Zeron Enterprises Inc (ZEI) is expected increase 0.5% from 6% to 6.5%. Caza claims that since ZEI will maintain their historic dividend payout ratio (g) of 50% and cost of equity (k) of 10%, ZEI's P/E ratio will also increase by 0.5%. Is Caza correct?

A) No, ZEI's P/E ratio will decrease by approximately 14.32%.

B) Yes, ZEI's P/E ratio will increase by approximately 0.5%.

C) No, ZEI's P/E ratio will increase by approximately 14.32%.

Q3. For which of the following firms is the Price/Earnings to Growth (PEG) ratio most appropriate for identifying undervalued or overvalued equities?

Firm A: Expected dividend growth = 6%; Cost of equity = 12%; price-to-earnings (P/E) = 12.
Firm B: Expected dividend growth = ?6%; Cost of equity = 12%; price-to-earnings (P/E) = 12.
Firm C: Expected dividend growth = 1%; Cost of equity = 12%; price-to-earnings (P/E) = 12.

A) Firm C.

B) Firm B.

C) Firm A.