Question

A research analyst is trying to determine whether a firm’s price-earnings (P/E) and price-sales (P/S) ratios can explain the firm’s stock performance over the past year. Generally, a high P/E ratio suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E ratio. Investors use the P/S ratio to determine how much they are paying for a dollar of the firm’s sales rather than a dollar of its earnings (P/E ratio).
In short, the higher the P/E ratio and the lower the P/S ratio, the more attractive the investment. The accompanying table shows a portion of the 2010 annual returns, the P/E ratios, and the P/S ratios for the 30 firms included in the Dow Jones Industrial Average. The entire data set, labeled Dow_2010, can be found on the text website.


a. Estimate: Return = β0 + β1P/E + β2P/S + . Show the regression results in a well-formatted table.
b. Determine whether P/E and P/S are jointly significant at the 5% significance level.
c. Establish whether the explanatory variables are individually significant at the 5% significance level.
d. What is the predicted return for a firm with a P/E ratio of 10 and a P/S ratio of 2? Use this value to construct the 95% confidence interval for the expectedreturn.


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  • CreatedJanuary 28, 2015
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