P/E ratio

CFA Level III
#1

EOC # 12 - first of all, how do you calculated justified p/e ratio? and how did they get 13.2?

Thanks,

#2

I wrote an article on justified ratios that may be of some help here: http://financialexamhelp123.com/justified-ratios-price-multiples/

#3

given the two numbers in the vignette - you cannot calculate the justified P/E ratio. But what they want you to do is to use the formula you know for the P/E ratio and determine the way the P/E would reduce when any of the parameters that determine P/E - viz volatilty reduces, growth increases or correlation of US with the world increases.

growth increases - (r-g) decreases - so P/E increases - bcos (r-g) is in the denominator.

correlation with world increases - risk increases - so required return r should increases - so P/E drops …ANS

volatily reduces - risk reduces - so required return r drops - (r-g) decreases - P/E increases.

#4

Thanks both of you.

#5

My pleasure.