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
3. This exercise is left to the student; answers will vary.
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
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
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6. a. Gold Mining. Gold traditionally is viewed as a hedge against inflation.
b. Construction. Expansionary monetary policy will lead to lower interest rates which
7. Supply-side economists believe that a reduction in income tax rates will make workers
8. a. The robotics process entails higher fixed costs and lower variable (labor) costs.
b. Because its profits are more sensitive to the business cycle, the robotics firm will
9. a. Housing construction (cyclical but interest-rate sensitive): (iii) Healthy expansion
10. a. Oil well equipment: Relative decline (Environmental pressures, decline in easily-
developed new oil fields)
11. a. General Autos. Pharmaceuticals are less of a discretionary purchase than
automobiles.
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12. The index of consumer expectations is a useful leading economic indicator because, if
13. 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
14. The expiration of the patent means that General Weedkillers will soon face considerably
greater competition from its competitors. We would expect prices and profit margins to
15. a. Expected profit = Revenues – Fixed costs – Variable costs
= $120,000 – $30,000 – [(1/3) $120,000] = $50,000
b.
60.1
000,50$
000,30$
1
profits
tscosfixed
1DOL =+=+=
c. If sales are only $108,000, profit will fall to:
d. The decrease in profit is 16%, which is equal to DOL times the 10% drop in
sales.
e. Profit must drop more than 100% to turn negative. For profit to fall 100%, revenue
must fall by:
%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:
Chapter 17 – Macroeconomic and Industry Analysis
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CFA PROBLEMS
1. a. Lowering reserve requirements would allow banks to lend out a higher fraction of
deposits and thus increase the money supply.
2. a. Expansionary monetary policy is likely to increase the inflation rate, either
because it may over stimulate the economy, or ultimately because the end result of
b. Real output and employment should increase in response to the expansionary
c. The real interest rate should fall, at least in the short-run, as the supply of funds to
d. The nominal interest rate could either increase or decrease. On the one hand, the
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
environment, profit margins and pricing strategies tend to shift as an industry
moves from one stage to the next, although it is generally difficult to identify
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Product pricing, profitability and industry competitive structure often vary by stage.
Thus, for example, the first stage usually encompasses high product prices, high
costs (R&D, marketing, etc.) and a (temporary) monopolistic industry structure. In
stage two (stable growth), new entrants begin to appear and costs fall rapidly due to
the learning curve. Prices generally do not fall as rapidly, however, allowing profit
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 information
c. Cars: In the final stages of the life cycle, demand tends to be price sensitive. Thus,
Universal can not raise prices without losing volume. Moreover, given the industry’s
maturity, cost structures are likely to be similar across all competitors, and any price
cuts can be matched immediately. Thus, Universal’s car business is boxed in: Product
pricing is determined by the market, and the company is a “price–taker.”
4. a. A basic premise of the business cycle approach to investment timing is that stock
prices anticipate fluctuations in the business cycle. For example, there is evidence
that stock prices tend to move about six months ahead of the economy. In fact,
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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 recommendation
economy.
5. a. • The industry-wide ROE is leveling off, indicating that the industry may be
approaching a later stage of the life cycle.
• Average P/E ratios are declining, suggesting that investors are becoming less
optimistic about growth prospects.
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:
• The population of 18-29 year olds, a major customer base for the industry, is
Chapter 17 – Macroeconomic and Industry Analysis
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• Automotive aftermarket industry retail sales have been growing slowly for several
years.
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:
• Sales growth of retail autoparts companies with 100 or more stores have been
growing rapidly and at an increasing rate.
(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
apparently is undergoing marketing innovation and consolidation. The industry is
7. i. Substitutes – one year from now: Currently the Carrycom, and other products in their
industry segment, have automatic language conversion functionality and geographic
region flexibility. This market segment is currently in a strong position.
ii. Threat of new (or potential) entrants – one year from now: Wade has no threat of
entrants into its market for the next three years because: (a) Wade has the exclusive
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Threat of new (or potential) entrants – five years from now: Beyond the next three
iii. Intensity of rivalry – one year from now: Wade will experience only modest rivalry for
three years as it has an exclusive production license for the next three years, which
limits the availability of similar products. However, the broader electronics market may
be integrating the automatic language conversion feature into its products after one year.
8. a. (iii)