CHAPTER 8— ECONOMIC AND INDUSTRY ANALYSIS
TRUE/FALSE
1. Complete consistency over time for different industries would indicate that industry analysis is not
necessary after market analysis.
2. Studies of industries indicate that their past performance can be useful in predicting future
performance.
3. While there is substantial dispersion in industry risk over periods of time, there is consistency in the
industry risk during a period of time.
4. The fact that all firms in an industry do not move together negates the value of industry analysis.
5. The micro approach to estimating the industry multiple would entail examining specific variables such
as: return on equity, earnings growth, and profit margin trend.
6. Structural changes occur when the economy undergoes a major organizational change or how it
functions.
7. “Downsizing” of corporate America in the 1990s is an example of structural change.
8. Switching from one industry group to another over the course of a business cycle is known as a
rotation strategy.
9. Assuming the Canadian dollar is strong relative to the German DM, it will be easier for the Canadian
paper industry to export to Germany.
10. When considering inputs, you would evaluate an industry’s prospects based on those of its raw
material suppliers, labour force, etc.
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11. The relationship between an economic series such as disposable personal income and industry sales is
usually stronger in an industry that is more specialized.
12. The earnings multiplier approach would be useful to predict the performance of the stock market.
13. In the rapid accelerating growth stage, profit margins are typically very high.
14. The industry life cycle can be rejuvenated at any stage by product innovations that attract new
customers or convince existing customers to buy the new product.
15. The relationship between an economic series such as disposable personal income and retail sales is
usually stronger in an industry that has become more specialized.
16. Global industry analysis must evaluate the effects not only of world supply, demand and cost
components for an industry, but also different valuation levels due to accounting conventions and the
impact of exchange rates.
17. The way to reduce the rivalry between existing competitors in an industry is to reduce the barrier to
entry to the industry.
18. When the government introduces a licensing requirement for an industry, it reduces the barriers to
entry for the industry.
19. In the rapid accelerating growth stage, profit margins are typically very high.
20. Because all firms in an industry do not move together there is little value in industry analysis.
21. While there is substantial dispersion in industry risk over periods of time, there is consistency in the
industry risk during a period of time.
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22. The rates of returns for firms within an industry vary which indicates that company analysis is
necessary after industry analysis.
23. Risk measures for different industries remain fairly constant over time so historical risk analysis can be
useful when estimating future risk.
24. Structural changes do have a cyclical pattern.
25. Switching industry groups over the course of a business cycle is known as a cyclical strategy.
26. Cyclical industries are attractive investments during the early stages of an economic recovery.
27. The capital goods industry typically outperforms other sectors during a recession.
28. Country risk is the uncertainty of earnings due to changes in exchange rates faced by firms in this
industry that sell outside the United States.
MULTIPLE CHOICE
1. What have studies found when analyzing risk levels among industries?
a.
risk levels vary among different industries.
b.
risk levels remained fairly constant across industries.
c.
risk levels for the same industry varied over time.
d.
risk levels for the same industry remain fairly constant over time.
e.
Choices a and d
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2. Which of the following statements about the business cycle is false?
a.
Toward the end of a recession, financial stocks typically increase in value as investment
and borrowing activities accelerate.
b.
Once the economy hits a trough and begins to recover, consumer durable stocks become
attractive investments.
c.
Once the economy has recovered and current levels of consumption are sustainable,
businesses may consider modernizing or expanding, thus stocks of capital goods industries
become attractive investments.
d.
As the business cycle reaches a peak, inflation rates decrease.
e.
None of the above (that is, all are true statements)
3. A number of economic variables affect both the economy and industries. Which of the following
statements is false?
a.
Industries with high levels of operating and financial leverage should benefit from lower
inflation rates.
b.
Banks generally benefit from volatile interest rates, while stable interest rates reduce
margins.
c.
Consumers who are optimistic about the economy will spend money on high-priced items,
such as autos and houses.
d.
The abundance or scarcity of input components can affect the perceived attractiveness of
an industry.
e.
None of the above (that is, all are true statements)
4. Which of the following is not considered a structural influence on the economy and industry?
a.
Demographics
b.
Life-styles
c.
International economics
d.
Social values
e.
Technology
5. What might cause an industry’s sales to decline?
a.
Changes in consumer tastes
b.
Product obsolescence
c.
Growth of substitute products
d.
Sluggish economic growth
e.
All of the above.
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6. Which of the following industries do not have a strong, consistent industry component?
a.
Gold
b.
Steel
c.
Railroads
d.
Tobacco
e.
Paper
7. Which of the following is not a stage in the industrial life cycle?
a.
Early pioneering development
b.
Rapid accelerating growth
c.
Acquisition and consolidation
d.
Mature growth
e.
Stabilization and market maturity
8. In which industrial life cycle stage do sales correlate highly with an economic series or the economy in
general?
a.
Pioneering development
b.
Rapidly accelerating growth
c.
Mature growth
d.
Stabilization and market maturity
e.
Deceleration of growth and decline
9. During which stage of the industrial life cycle is the product or service recognized as viable and the
demand substantial?
a.
Early pioneering development
b.
Rapid accelerating growth
c.
Acquisition and consolidation
d.
Mature growth
e.
Stabilization and market maturity
10. At what stage in the industrial life cycle is there an influx of competition?
a.
Early pioneering development
b.
Rapid accelerating growth
c.
Acquisition and consolidation
d.
Mature growth
e.
Stabilization and market maturity
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11. Which of the following is not a competitive force suggested by Porter?
a.
Rivalry among existing competitors
b.
Threat of new entrants
c.
Threat of substitute products
d.
Government and regulatory influences
e.
None of the above (that is, all are competitive forces)
12. Which of the following statements concerning the competitive environment is true?
a.
High fixed costs encourage firms to produce at a low level of capacity, in order to
minimize fixed cost per unit produced.
b.
Low current prices relative to costs in an industry indicate low barriers to entry.
c.
Substantial economies of scale do not give a current industry member an advantage over a
new firm.
d.
The ability to substitute another product limits the industry’s profit potential.
e.
Buyers and suppliers do not influence the profitability of an industry.
13. The financial risk for the retail store industry is difficult to judge because of
a.
Convertible debt.
b.
Numerous building leases.
c.
Warrants.
d.
Variable operating profits.
e.
Extensive use of preferred stock.
14. Which of the following is needed to forecast the performance of the stock market using P/E?
a.
The future earnings per share for the stock market
b.
The earnings multiplier for the stock market
c.
The earnings multiplier for the key industries
d.
Choices a and b.
e.
None of the above.
15. When forecasting industry sales it can be useful to
a.
Utilize the industry life cycle.
b.
Use earnings multiplier of the stock market.
c.
Use the relationship between an industry and the aggregate economy.
d.
All of the above.
e.
Choices b and c.
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16. The ____ of an industry is a function of retention rate and return on equity.
a.
Expected return
b.
Expected business risk
c.
Expected financial risk
d.
Expected growth rate
e.
Expected sales volatility
17. Toward the end of a recession,
a.
financial stock rise on expectations of increases in loan demand, housing constructions and
security offerings.
b.
consumer durable stocks rise on expectations of rising consumer confidence and personal
income.
c.
capital goods stocks rise on expectation of increases in business capital spending.
d.
basic materials stocks rise on expectation of rising profit margins.
e.
consumer staple stocks rise on expectations that consumers will continue to spend on
necessities.
18. At the initial stage of an economic recovery,
a.
financial stock rise on expectations of increases in loan demand, housing constructions and
security offerings.
b.
consumer durable stocks rise on expectations of rising consumer confidence and personal
income.
c.
capital goods stocks rise on expectation of increases in business capital spending.
d.
basic materials stocks rise on expectation of rising profit margins.
e.
consumer staple stocks rise on expectations that consumers will continue to spend on
necessities.
19. Once it becomes clear the economy is recovering,
a.
financial stock rise on expectations of increases in loan demand, housing constructions and
security offerings.
b.
consumer durable stocks rise on expectations of rising consumer confidence and personal
income.
c.
capital goods stocks rise on expectation of increases in business capital spending.
d.
basic materials stocks rise on expectation of rising profit margins.
e.
consumer staple stocks rise on expectations that consumers will continue to spend on
necessities.
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20. Toward the business cycle peak
a.
financial stock rise on expectations of increases in loan demand, housing constructions and
security offerings.
b.
consumer durable stocks rise on expectations of rising consumer confidence and personal
income.
c.
capital goods stocks rise on expectation of increases in business capital spending.
d.
basic materials stocks rise on expectation of rising profit margins.
e.
consumer staple stocks rise on expectations that consumers will continue to spend on
necessities.
21. During a recession,
a.
financial stock rise on expectations of increases in loan demand, housing constructions and
security offerings.
b.
consumer durable stocks rise on expectations of rising consumer confidence and personal
income.
c.
capital goods stocks rise on expectation of increases in business capital spending.
d.
basic materials stocks rise on expectation of rising profit margins.
e.
consumer staple stocks rise on expectations that consumers will continue to spend on
necessities.
22. Which of the following statements is not true?
a.
During a specific time period, rates of return across industry do not vary substantially.
b.
The rates of return for individual industries do vary substantially over time.
c.
During a specific time period, rates of return within industries do vary substantially.
d.
Risk measures for individual industries remain relatively constant over time.
e.
None of the above (that is, all are true statements)
23. Which of the following statements about industry analysis is true?
a.
During any time period, rates of return of firms within industries do vary within a wide
range.
b.
Aggregate market performance accurately reflects the performance of alternative
industries.
c.
Risk of return for individual industries have not varied over time, so one can simply
extrapolate past performance into the future.
d.
All of the above.
e.
None of the above.
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24. If the economic outlook was such that you expected corporate earnings to decline, consumers have
excessive levels of debt, and there is significant overcapacity in the technology sector, then an
appropriate asset allocation policy would be to:
a.
Overweight equity especially technology stocks and underweight bonds
b.
Underweight equity especially technology stocks and overweight bonds
c.
Overweight equity especially technology stocks and overweight bonds
d.
Underweight equity especially technology stocks and underweight bonds
e.
None of the above.
25. Which of the following economic variables does not have an impact on industry analysis?
a.
Inflation
b.
Interest rates
c.
International economics
d.
Consumer sentiment
e.
None of the above (that is, all of the above economic variables have at least some impact
on industry analysis)
26. A number of factors affect the cash flow and risk prospects of different industries. Which of the
following is not such a factor?
a.
Demographics
b.
Life-styles
c.
Technology
d.
Politics
e.
None of the above (that is, all are factors to be considered)
27. What should analysts identify and monitor?
a.
The current and emerging trends and patterns affecting an industry.
b.
The indicators of trends and patterns in structural factors.
c.
The momentum toward change in trends and patterns in structural factors.
d.
All of the above.
e.
Choices a and b.
28. Which of the following is not considered a basic competitive force?
a.
Rivalry among existing competitors
b.
Threat of new entrants
c.
Threat of substitute products
d.
Threat of government interference
e.
Bargaining power of buyers and suppliers
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29. Which of the following is not characteristic of the “growth” phase in the industry life cycle?
a.
Consumer will accept uneven quality
b.
Products have technical and performance differentiation
c.
High advertising costs
d.
Low profits
e.
Many competitors
30. Which of the following is not characteristic of the “decline” phase of the industry life cycle?
a.
Little product differentiation
b.
Substantial manufacturing overcapacity
c.
Many competitors
d.
Falling prices
e.
None of the above (this is, all are characteristics of the “decline” phase)
31. Which of the following statements regarding cyclical industries is true?
a.
Cyclical industries are affected by changes in consumer sentiment.
b.
Cyclical industries are not affected by changes in consumer sentiment.
c.
Cyclical industries often outperform other sectors during a recession.
d.
All of the above are true.
e.
None of the above are true.
32. During which industry life cycle stage do firms experience low rates of return on capital and investors
begin to seek alternative uses of capital?
a.
Pioneering and development
b.
Mature growth
c.
Stabilization and market maturity
d.
Deceleration of growth and decline
e.
Disassembly and restructure
33. Which of the following are not typically considered a threat of new entrants to an industry?
a.
Low current prices relative to costs
b.
Large capital requirements
c.
Extensive distribution channels with exclusive distribution contracts
d.
Government policy restricting access to raw materials
e.
Large volume purchases relative to the sales of a supplier
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34. Which of the following statements regarding global portfolio is true?
a.
Decrease the asset allocation to the country with pessimistic economic scenario .
b.
Increase the asset allocation to the country with pessimistic economic scenario.
c.
Increase the asset allocation to the country with optimistic economic scenario.
d.
Both a and c are true
e.
All of the above are true
35. Which of the following statements is false?
a.
Financial institutions are typically adversely impacted by higher rates of interest.
b.
Industries with high operating leverage typically benefit with inflation when their costs are
fixed in nominal terms.
c.
Industries with low financial leverage typically outperform firms with higher leverage
when inflation increases.
d.
A weaker Canadian dollar typically helps Canadian industries.
e.
Consumer cyclical industries are affected by increasing interest rates.
Exhibit 8-1
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Assume that you are an analyst for the Canadian auto parts industry. Consider the following
information that you propose to use to obtain an estimate of year 2010 EPS for the Canadian auto parts
industry
Year 2009
Estimated Year 2010
Personal consumption expenditures
$6,800 billion
Personal consumption expenditures growth
1.5%
Industry Sales per share
$525
Industry Operating profit margin
15%
Industry Depreciation/Fixed Assets
8.25%
Industry Fixed asset turnover
3
Interest rate
6%
Industry Total asset turnover
1.2
Industry Debt/Total assets
45%
Industry Tax rate
36%
In addition a regression analysis indicates the following relationship between growth in industry sales
per share and personal consumption expenditures (PCE) growth is
% Sales per share = 0.02 + 1.5(% PCE)
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36. Refer to Exhibit 8-1. Calculate personal consumption expenditures for the year 2010.
a.
$7,500 billion
b.
$7,000 billion
c.
$7140 billion
d.
$7,550.5 billion
e.
$6,825.75 billion
37. Refer to Exhibit 8-1. Estimate the industry growth rate in sales per share.
a.
10.5%
b.
11%
c.
12.16%
d.
9.5%
e.
8.73%
38. Refer to Exhibit 8-1. Estimate the industry sales per share for the year 2010.
a.
$574.9
b.
$600.0
c.
$585.03
d.
$625
e.
$550
39. Refer to Exhibit 8-1. Calculate the industry year 2010 EBITDA per share.
a.
$95.05
b.
$89.15
c.
$92.56
d.
$94.73
e.
$86.23
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40. Refer to Exhibit 8-1. Obtain an estimate of the per share depreciation charge for the year 2010.
a.
$15.81
b.
$12.35
c.
$23.68
d.
$25.93
e.
$35
41. Refer to Exhibit 8-1. Calculate the per share EBIT for the year 2010.
a.
$95.33
b.
$70.42
c.
$85.56
d.
$95.89
e.
$75.32
42. Refer to Exhibit 8-1. Calculate industry Total Assets per share for the year 2010.
a.
$450
b.
$565.67
c.
$513.58
d.
$479.07
e.
$385.77
43. Refer to Exhibit 8-1. Calculate industry level of debt for the year 2010.
a.
$215.58
b.
$300.75
c.
$237.67
d.
$285.98
e.
$193.72
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44. Refer to Exhibit 8-1. Calculate the per share interest rate charge for the year 2010.
a.
$12.93
b.
$17.72
c.
$10.07
d.
$13.76
e.
$18.59
45. Refer to Exhibit 8-1. Calculate the industry EBT per share for the year 2010.
a.
$53.29
b.
$67.89
c.
$68.75
d.
$59.63
e.
$57.49
46. Refer to Exhibit 8-1. Calculate industry EPS for the year 2010.
a.
$45.25
b.
$36.79
c.
$57.25
d.
$32.56
e.
$48.57