The following were the P/E ratios of firms in the aerospace/defense industry at
ID: 2729434 • Letter: T
Question
The following were the P/E ratios of firms in the aerospace/defense industry at the end of December 1993, with additional data on expected growth and risk. The risk-free rate in the US at the end of 1993 is 7.5 percent and the US market risk premium is 5.5 percent.
Company
P/E ratio
Expected growth
Beta
Dividend payout ratio
Boeing
17.3
3.5%
1.10
28%
General Dynamics
15.5
11.5%
1.25
40%
GM - Hughes
16.5
13.0%
0.85
41%
Grumman
11.4
10.5%
0.80
37%
Lockheed Corp.
10.2
9.5%
0.85
37%
Logicon
12.4
14.0%
0.85
11%
McDonnell Douglas
22.6
13.0%
1.15
37%
Northrop
9.5
9.0%
1.05
47%
Raytheon
12.1
9.5%
0.75
28%
Thiokol
8.7
5.5%
0.95
15%
Average
13.62
9.9%
0.96
32.1%
An analyst concludes that Thiokol is undervalued because its P/E ratio is lower than the industry average. The same analyst thinks that McDonnell Douglas is overvalued because its P/E ratio is high.
Question: Under what conditions are these statements true? Would you agree with these statements given the data in the table?
Company
P/E ratio
Expected growth
Beta
Dividend payout ratio
Boeing
17.3
3.5%
1.10
28%
General Dynamics
15.5
11.5%
1.25
40%
GM - Hughes
16.5
13.0%
0.85
41%
Grumman
11.4
10.5%
0.80
37%
Lockheed Corp.
10.2
9.5%
0.85
37%
Logicon
12.4
14.0%
0.85
11%
McDonnell Douglas
22.6
13.0%
1.15
37%
Northrop
9.5
9.0%
1.05
47%
Raytheon
12.1
9.5%
0.75
28%
Thiokol
8.7
5.5%
0.95
15%
Average
13.62
9.9%
0.96
32.1%
Explanation / Answer
Answer: The given statement is true only in the following conditions a) Thiokal and McDonnell Douglas has approximately similar growth rate and risk structure in comparision with Industry's growth rate and risk structure. b) Companies must have higher growth rate in comparision to industry's growth rate. c) Companies must have lower risk premium in comparision to Industry risk premium. No, we are not agree with this statement because in the given data Growth rate and risk potential(beta) is disimilar with industry average.
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