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CHAPTER 17: MACROECONOMIC AND INDUSTRY ANALYSIS
CHAPTER 17: MACROECONOMIC AND INDUSTRY ANALYSIS
PROBLEM SETS
1. Expansionary (looser) monetary policy to lower interest rates would stimulate both
investment and expenditures on consumer durables. Expansionary fiscal policy (i.e.,
3. This exercise is left to the student; answers will vary. Successful students will likely
4. A top-down approach to security valuation begins with an analysis of the global and
domestic economy. Analysts who follow a top-down approach then narrow their
attention to an industry or sector likely to perform well, given the expected
performance of the broader economy. Finally, the analysis focuses on specific
companies within an industry or sector that has been identified as likely to perform
5. Firms with greater sensitivity to business cycles are in industries that produce
durable consumer goods or capital goods. Consumers of durable goods (e.g.,
automobiles, major appliances) are more likely to purchase these products during an
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CHAPTER 17: MACROECONOMIC AND INDUSTRY ANALYSIS
6. a. Gold Mining. Gold traditionally is viewed as a hedge against inflation.
b. Construction. Expansionary monetary policy will lead to lower interest rates
7. Supply-side economists believe that a reduction in income tax rates will make
8. a. When both fiscal and monetary policies are expansive, the yield curve is
9. a. When wealth is redistributed through the government’s tax policy, economic
10. a. The robotics process entails higher fixed costs and lower variable (labor)
11. a. Housing construction (cyclical but interest-rate sensitive): (iii) Healthy expansion
12. a. Oil well equipment: Relative decline (Environmental pressures, decline in
easily developed new oil fields)
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CHAPTER 17: MACROECONOMIC AND INDUSTRY ANALYSIS
14. The index of consumer expectations for business conditions is a useful leading
economic indicator because, if consumers are optimistic about the future, they will
15. Labor cost per unit is a useful lagging indicator because wages typically start rising
only well into an economic expansion. At the beginning of an expansion, there is
16. The expiration of the patent means that General Weedkillers will soon face
considerably greater competition from its competitors. We would expect prices and
17. a. Expected profit = Revenues – Fixed costs – Variable costs
b.
Fixed costs $30,000
DOL 1 1 1.60
Profits $50,000
= + = + =
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CHAPTER 17: MACROECONOMIC AND INDUSTRY ANALYSIS
%5.62
60.1
%100
DOL
%100
Therefore, revenue would be only 37.5% of the original forecast. At this level,
revenue will be: 0.375 $120,000 = $45,000
f. If revenue is $45,000, profit will be:
$45,000 – $30,000 – (1/3) $45,000 = $0
18. Equity prices are positively correlated with job creation or longer work weeks, as
19. a. Stock prices are one of the leading indicators. One possible explanation is that
stock prices anticipate future interest rates, corporate earnings, and dividends.
20. a. Industrial production is a coincident indicator; the others are leading.
21. b. If historical returns are used, the arithmetic and geometric means of returns are
available. The geometric mean is preferred for multiperiod horizons to observe
long-term trends. An alternative to the equity risk premium is to use a moving
22. a. Foreign exchange rates can significantly affect the competitiveness and
profitability for a given industry. For industries that derive a significant proportion
23. Determinants of buyer power include buyer concentration, buyer volume, buyer
information, available substitutes, switching costs, brand identity, and product
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CHAPTER 17: MACROECONOMIC AND INDUSTRY ANALYSIS
25. A firm with a strategic planning process not guided by its generic competitive
strategy usually makes one or more of the following mistakes:
1. The strategic plan is a list of unrelated action items that do not lead to a
2. Price and cost forecasts are based on current market conditions and fail
3. Business units are placed into categories such as build, hold, and
4. The firm focuses on market share as a measure of competitive position,
Smith’s observations 2 and 3 describe two of these mistakes and therefore do not
26. a.
Fixed costs $7,000,000
DOL 1 1 2.75
Profits $4,000, 000
Fixed costs $5, 000,000
DOL 1 1 2.25
Profits $4,000, 000
Atech
ZTech
= + = + =
= + = + =
b. ATech, is likely to have higher profits if the economy strengthens since it has a
higher DOL. Firms with high fixed costs are said to have high operating leverage,
because small swings in business conditions can have large impacts on
profitability.
27. a. Sales:
CHAPTER 17: MACROECONOMIC AND INDUSTRY ANALYSIS
$200 2,000,000 $400,000, 000
$200 1,000, 000 $200,000, 000
$200,000,000 $400,000, 000
% .5000 50.00%
$400,000,000
strong
recession
sales
Sales
Sales
= ´ =
= ´ =
-
D = =- =-
b. Profit
Profits [ ] (1 )
Price per unit
Quantity of units sold
Variable Costs per unit
Fixed Costs
Tax Rate
Profits [$200 2, 000,000 $140 2,000,000 $30,000,000] (1 .3)
$63, 000,000
P
strong
P Q VC Q FC t
where
P
Q
VC
FC
t
= ´ - ´ - ´ -
=
=
=
=
=
= ´ - ´ - ´ -
=
rofits [$200 1, 000,000 $140 1, 000,000 $30,000,000] (1 .3)
$21, 000,000
$21, 000,000 $63, 000,000
% .6667 66.67%
$63,000,000
recession
profits
= ´ - ´ - ´ -
=
-
D = =- =-
c. The DOL can be calculated by taking the percent change in profits and
dividing by the percent change in sales:
%66.67% 1.3333
% 50.00%
profits
sales
DOL D-
= = =
D -
CFA PROBLEMS
1. a. Lowering reserve requirements would allow banks to lend out a higher
CHAPTER 17: MACROECONOMIC AND INDUSTRY ANALYSIS
2. a. Expansionary monetary policy is likely to increase the inflation rate, either
c. The real interest rate should fall, at least in the short-run, as the supply of
funds to the economy has increased.
d. The nominal interest rate could either increase or decrease. On the one hand,
3. a. The concept of an industrial life cycle refers to the tendency of most industries
to go through various stages of growth. The rate of growth, the competitive
The start-up stage is characterized by perceptions of a large potential market
and by a high level of optimism for potential profits. However, this stage
usually demonstrates a high rate of failure. In the second stage, often called
Product pricing, profitability, and industry competitive structure often vary by
stage. Thus, for example, the first stage usually encompasses high product
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CHAPTER 17: MACROECONOMIC AND INDUSTRY ANALYSIS
b. The passenger car business in the United States has probably entered the final
stage in the industrial life cycle because normalized growth is quite low. The
c. Cars: In the final stages of the life cycle, demand tends to be price sensitive.
Thus, Universal cannot raise prices without losing volume. Moreover, given the
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CHAPTER 17: MACROECONOMIC AND INDUSTRY ANALYSIS
Idata: Idata should have much more pricing flexibility given its earlier stage in
the industrial life cycle. Demand is growing faster than supply, and depending on
4. a. A basic premise of the business cycle approach to investment timing is that
Over the course of a business cycle, this approach to investing would work
roughly as follows. As the investor perceives that the top of a business cycle is
approaching, stocks purchased should not be vulnerable to a recession. When
Generally, abnormal returns can be earned only if these asset allocation
b. Based on the business cycle approach to investment timing, the ideal time to
invest in a cyclical stock such as a passenger car company would be just
before the end of a recession. If the recovery is already underway, Adam’s
5. a. The industrywide ROE is leveling off, indicating that the industry may be
Average P/E ratios are declining, suggesting that investors are becoming
Dividend payout is increasing, suggesting that the firm sees less reason to
Industry dividend yield is also increasing, even though market dividend
b. Industry growth rate is still forecast at 10% to 15%, higher than would be
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CHAPTER 17: MACROECONOMIC AND INDUSTRY ANALYSIS
6. a. Relevant data from the table supporting the conclusion that the retail auto
parts industry as a whole is in the maturity stage of the industry life cycle are:
b. (i) Relevant data from the table supporting the conclusion that Wigwam
Autoparts Heaven, Inc. (WAH) and its principal competitors are in the
consolidation stage of their life cycle are:
(ii) Because of industry fragmentation (i.e., most of the market share is distributed
among many companies with only a few stores), the retail autoparts industry
7. a. (iii)
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CHAPTER 17: MACROECONOMIC AND INDUSTRY ANALYSIS
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