1. Currently, the dividend=payout ratio (D/E) for the aggregate market is 60 percent, the required return (k) is 11 percent, and the expected growth rate for dividends (g) is 5 percent.

a. Compute the current earnings multiplier

b. You expect the D/E payout ratio to decline to 50 percent, but you assume there will be no other changes. What will be the P/E?

c. Starting with the initial conditions, you expect the dividend-payout ratio to be constant. The rate of inflation to increase by 3 percent and the growth rate to increase by 2 percent. Compute the expected P/E.

d. Starting with the initial conditions, you expect the dividend-payout ratio to be constant, the rate of inflation to decline by 3 percent, and the growth rate to decline by 1 percent. Compute the expected P/E.

2. Given the three EPS estimates in Problem 6, you are also given the following estimates related to the market earnings multiple:

Pessimistic      Consensus       Optimistic

D/E                                          0.65                 0.55                 0.45

Nominal RFR                           0.10                 0.09                 0.08

Risk premium                          0.05                 0.04                 0.03

ROE                                         0.11                 0.13                 0.15

a. Based on the three EPS and P/E estimates, compute the high, low, and consensus intrinsic market value for the S&P Industrials Index in 2013.

b. Assuming that the S&P Industrials Index at the beginning of the year was priced at 2.050, compute your estimated rate of return under three scenarios from Part a. Assuming your required rate of return is equal to the consensus, how would you weigh the S&P Industrials Index in your global portfolio?

3. You are analyzing the U.S. equity market based upon the S&P Industrials Index and using the present value of free cash flow to equity technique. Your inputs are as follows:

Beginning FCFE: $80

K = 0.09

Growth Rate:

Year 1-3:                     9%

         4-6:                     8%

         7 and beyond:    7%

a. Assuming that the current value for the S&P Industrials Index is 2,050, would you underweight, overweight, or market weight the U.S. equity market?

b. Assume that there is a 1 percent increase in the rate of inflation - what would be the market's value, and how would you weigh the U.S. market? State your assumptions.