20. (Adapted from 2001 CFA Level II exam) Peninsular Research is initiating coverage of a mature manufacturing industry. John Jones, CFA, head of the research department, gathers the information given in Table 2-19 to help in his analysis.

TABLE 2-19 Fundamental Industry and Market Data Forecasted industry earnings retention rate 40%

Forecasted industry return on equity 25%

Industry beta 1.2 Government bond yield 6%

Equity risk premium 5%

A. Compute the price-to-earnings (P0/E1) ratio for the industry based on the fundamental data in Table 2-19. Show your work.

Jones wants to analyze how fundamental P/Es might differ among countries. He gathers the data given in Table 2-20.

TABLE 2-20 Economic and Market Data Fundamental Factors Country A Country B Forecasted growth in real gross domestic product 5% 2%

Government bond yield 10% 6%

Equity risk premium 5% 4%

B. Determine whether each of the fundamental factors in Table 2-20 would cause P/Es to be generally higher for Country A or higher for Country B. Justify each of your conclusions with one reason. Note: Consider each fundamental factor in isolation, with all else remaining equal.

TABLE 2-21 Valuation Information: December 1997 QuickBrush SmileWhite Beta 1.35 1.15 Market price $45.00 $30.00 Intrinsic value $63.00 ?
Notes:
Risk-free rate 4.50%
Expected market return 14.50%