Chap 017

Chapter 17 - Macroeconomic and Industry Analysis
Chapter 17
Macroeconomic and Industry Analysis
Multiple Choice Questions
1. A top down analysis of a firm starts with ____________.
A. the relative value of the firm
B. the absolute value of the firm
C. the domestic economy
D. the global economy
E. the industry outlook
A top down analysis of a firm starts with the global economy.
Difficulty: Easy
2. An example of a highly cyclical industry is ________.

A. the automobile industry
B. the tobacco industry
C. the food industry
D. A and B
E. B and C
Consumer durables, such as automobiles, are highly cyclical as purchases can be delayed until
good times. Necessities, low-ticket items, and addictive products are purchased in good times
and bad.
Difficulty: Easy
17-1
3. Demand-side economics is concerned with _______.

A. government spending and tax levels
B. monetary policy
C. fiscal policy
D. A and B
E. A, B, and C
Demand-side economics is concerned with monetary and fiscal policy (government spending
and taxing).
Difficulty: Easy
4. The most widely used monetary tool is ___________.

A. altering the discount rate
B. altering the reserve requirements
C. open market operations
D. altering marginal tax rates
E. none of the above
The Federal Reserve's open market operations are the most widely used and most effective
monetary tool for influencing interest rates.
Difficulty: Easy
5. The "real", or inflation-adjusted, exchange rate, is

A. the balance of trade.
B. the budget deficit.
C. the purchasing power ratio.
D. unimportant to the U.S economy.
E. none of the above.
The ratio of one country's purchasing power to another's is called the "real", or inflation
adjusted, exchange rate, and is an important measure of the relative costs of domestic versus
foreign goods.
Difficulty: Easy
17-2
6. The "normal" range of price-earnings ratios for the S&P 500 Index is
A. between 2 and 10.
B. between 5 and 15.
C. less than 8.
D. between 12 and 25
E. greater than 20.
Stock prices commonly trade at between 12 and 25 times earnings.
Difficulty: Moderate
7. Monetary policy is determined by

A. government budget decisions.
B. presidential mandates.
C. the board of Governors of the Federal Reserve System.
D. congressional actions.
The Board of Governors of the Federal Reserve System determines monetary policy through
open market operations, changes in the discount rate and reserve requirement adjustments.
Difficulty: Easy
8. A trough is ________.
A. a transition from an expansion in the business cycle to the start of a contraction
B. a transition from a contraction in the business cycle to the start of an expansion
C. a depression that lasts more than three years.
D. only something used by farmers to feed pigs and not an investment term
The trough occurs when the economy has hit "rock bottom" in the business cycle and
recovery is ahead.
Difficulty: Easy
17-3
9. A peak is ________.
A. a transition from an expansion in the business cycle to the start of a contraction
B. a transition from a contraction in the business cycle to the start of an expansion
C. a depression that lasts more than three years.
D. only something used by farmers to feed pigs and not an investment term
The peak occurs when the economy has hit the top in the business cycle.
Difficulty: Easy
10. If the economy is growing, firms with high operating leverage will experience
__________.
A. higher increases in profits than firms with low operating leverage.
B. similar increases in profits as firms with low operating leverage.
C. smaller increases in profits than firms with low operating leverage.
D. no change in profits.
As sales increase, firms with high operating leverage spread these fixed costs over more units
and thus increase profits.
Difficulty: Easy
11. If the economy is shrinking, firms with high operating leverage will experience
__________.
A. higher decreases in profits than firms with low operating leverage.
B. similar decreases in profits as firms with low operating leverage.
C. smaller decreases in profits than firms with low operating leverage.
As sales decrease, firms with high operating leverage spread these fixed costs over fewer units
and thus decrease profits.
Difficulty: Easy
17-4
12. If the economy is growing, firms with low operating leverage will experience
__________.
A. higher increases in profits than firms with high operating leverage.
B. similar increases in profits as firms with high operating leverage.
C. smaller increases in profits than firms with high operating leverage.
As sales increase, firms with high operating leverage spread these fixed costs over more units
and thus increase profits.
Difficulty: Easy
13. If the economy is shrinking, firms with low operating leverage will experience
__________.
A. higher decreases in profits than firms with high operating leverage.
B. similar decreases in profits as firms with high operating leverage.
C. smaller decreases in profits than firms with high operating leverage.
As sales decrease, firms with high operating leverage spread these fixed costs over fewer units
and thus decrease profits.
Difficulty: Easy
14. Industrial production refers to _________.

A. the amount of personal disposable income in the economy.
B. the difference between government spending and government revenues.
C. the total manufacturing output in the economy.
D. the total production of goods and services in the economy
Industrial production is a measure of the productive output of the manufacturing sector of the
economy.
Difficulty: Easy
17-5
15. GDP refers to _________.

A. the amount of personal disposable income in the economy.
B. the difference between government spending and government revenues.
C. the total manufacturing output in the economy.
D. the total production of goods and services in the economy
GDP is a measure of the productive output of the country, both in terms of goods and services.
Difficulty: Easy
16. A rapidly growing GDP indicates a(n) ______ economy with ______ opportunity for a
firm to increase sales.
A. stagnant; little
B. stagnant; ample
C. expanding; little
D. expanding; ample
E. stable; no
GDP is a measure of the productive output of the country and indicated the opportunities
firms have to expand sales.
Difficulty: Easy
17. A declining GDP indicates a(n) ______ economy with ______ opportunity for a firm to
increase sales.
A. stagnant; little
B. stagnant; ample
C. expanding; little
D. expanding; ample
E. stable; no
GDP is a measure of the productive output of the country and indicated the opportunities
firms have to expand sales.
Difficulty: Easy
17-6
18. The average duration of unemployment and changes in the consumer price index for
services are _________.
A. leading economic indicators
B. coincidental economic indicators
C. lagging economic indicators
D. composite economic indicators
These indicators (C) lag the general economy, and are indicators that the economy is about to
change directions.
19. A firm in an industry that is very sensitive to the business cycle will likely have a stock
beta ___________.
A. greater than 1.0
B. equal to 1.0
C. less than 1.0 but greater than 0.0
D. equal to or less than 0.0
E. There is no relationship between beta and sensitivity to the business cycle.
Cyclical stocks are more volatile than the market in general, and thus have betas greater than
1.0.
17-7
20. If the economy were going into a recession, an attractive industry to invest in would be the
________ industry.
A. automobile
B. medical services
C. construction
D. A and C
E. B and C
Medical services are necessities, and thus perform about the same regardless of the business
cycle. Automobile and construction industries are cyclical, and perform poorly during
recessions.
Difficulty: Easy
21. The stock price index and contracts and new orders for nondefense capital goods are
A. leading economic indicators.
B. coincidental economic indicators.
C. lagging economic indicators.
D. not useful as economic indicators.
Contracts and orders for plant and equipment are indicative of future economic times, and
thus are leading economic indicators. The stock price index is one of the best leading
economic indicators, a reflection of market efficiency.
22. A firm in the early stages of the industry life cycle will likely have ________.
A. high market penetration.
B. high risk.
C. rapid growth
D. A and C
E. B and C
In the early stages of the industry life cycle, the firm is likely to be high in risk.
Difficulty: Easy
17-8
23. Assume the U.S. government was to decide to increase the budget deficit. This action will
most likely cause __________ to increase
A. interest rates
B. government borrowing
C. unemployment
D. both A and B
Increasing the deficit raises government borrowing, increases the demand for funds and thus
increases the interest rates. Deficit spending is also used to stimulate the economy by
encouraging increasing the output of economy.
Difficulty: Easy
24. Assume the U.S. government was to decide to decrease the budget deficit. This action will
most likely cause __________ to decrease
A. interest rates
C. unemployment
D. both A and B
decreasing the deficit lowers government borrowing, decreases the demand for funds and thus
decreases the interest rates.
Difficulty: Easy
17-9
25. Assume that the Federal Reserve decreases the money supply. This action will cause
________ to decrease.
A. interest rates
B. the unemployment rate
C. investment in the economy
D. trade balance
Decreasing the money supply is an economic contraction strategy, resulting in a decreased
output of the economy.
Difficulty: Easy
26. If the currency of your country is depreciating, the result should be to ______ exports and
to _______ imports.
A. stimulate, stimulate
B. stimulate, discourage
C. discourage, stimulate
D. discourage, discourage
E. not affect, not affect
Depreciating currency means that country's goods and services are cheaper and thus that
country's exports are stimulated. Likewise, goods and services of other countries are now
more expensive; and thus production is discouraged.
17-10
27. If the currency of your country is appreciating, the result should be to ______ exports and
to _______ imports.
A. stimulate, stimulate
B. stimulate, discourage
C. discourage, stimulate
D. discourage, discourage
E. not affect, not affect
An appreciating currency means that country's goods and services are more expensive to
foreigners and thus that country's exports are discourages. Likewise, goods and services of
other countries are now less expensive; and thus imports are stimulated.
28. Increases in the money supply will cause demand for investment and consumption goods
to _______ in the short run and cause prices to ________ in the long run.
A. increase, increase
B. increase, decrease
C. decrease, increase
D. decrease, decrease
E. be unaffected, be unaffected
An increase in the money supply results in increased demand for goods and services, which
ultimately is reflected in higher prices for these goods and services.
29. The North American Industry Classification System (NAICS)

A. are for firms that operate in the NAFTA region.
B. group firms by industry.
C. are a perfect classification system for firms.
D. A and B.
E. A and C.
The NAICS is a grouping of NAFTA firms by industry. However, the classification system is
not perfect as firms with dissimilar clients may be classified in one category.
Difficulty: Easy
17-11
17-12
30. If interest rates increase, business investment expenditures are likely to ______ and
consumer durable expenditures are likely to _________.
E. be unaffected, be unaffected.
As interest rates increase, it becomes too expensive for businesses to increase their investment
expenditures and the fewer durable goods produced become more expensive.
31. Fiscal policy generally has a _______ direct impact than monetary policy on the economy,
and the formulation and implementation of fiscal policy is ______ than that of monetary
policy.
A. more, quicker
B. more, slower
C. less, quicker
D. less, slower
E. Cannot tell from the information given.
Fiscal policy has a more direct impact on the economy than does monetary policy. However,
the formulation and implementation of fiscal policy is much slower than monetary policy.
Monetary policy is determined by the Federal Reserve System. Fiscal policy must be
deliberated, passed, and implemented by both the executive and legislative branches of the
federal government.
17-13
32. Fiscal policy is difficult to implement quickly because

A. it requires political negotiations.
B. much of government spending is nondiscretionary and cannot be changed.
C. increases in tax rates affect consumer spending gradually.
D. A and B.
E. A and C.
Fiscal policy must be negotiated and can change only discretionary items within the budget,
making it more difficult to implement. However, fiscal policy changes affect consumer
spending almost immediately.
Difficulty: Easy
33. Inflation
A. is the rate at which the general level of prices is increasing.
B. rates are high when the economy is considered to be "overheated".
C. is unrelated to unemployment rates.
D. A and B.
E. A and C.
A and B are true. The government attempts to walk the fine line between the trade offs
between unemployment and inflation.
Difficulty: Easy
Two firms, A and B, both produce widgets. The price of widgets is $1 each. Firm A has total
fixed costs of $500,000 and variable costs of 50 cents per widget. Firm B has total fixed costs
of $240,000 and variable costs of 75 cents per widget. The corporate tax rate is 40%. If the
economy is strong, each firm will sell 1,200,000 widgets. If the economy enters a recession,
each firm will sell 1,100,000 widgets.
17-14
34. If the economy enters a recession, the after-tax profit of Firm A will be ________.
A. $0
B. $6,000
C. $30,000
D. $60,000
$1,100,000 - 500,000 FC - 0.5($1,100,000) VC = ($50,000)(1-.4) = $30,000
35. If the economy enters a recession, the after-tax profit of Firm B will be _______.
A. $0
B. $6,000
C. $36,000
D. $60,000
$1,100,000 - $240,000 FC - 0.75(1,100,000) VC = $-35,000 (1 - 0.4) = -$21,000.
36. If the economy is strong, the after-tax profit of Firm A will be _______.
A. $0
B. $6,000
C. $36,000
D. $60,000
$1,200,000 - $500,000 FC- 0.5(1,200,000) VC = $100,000 (1 - 0.4) = $60,000.
17-15
37. If the economy is strong, the after-tax profit of Firm B will be __________.
A. $0
B. $6,000
C. $36,000
D. $60,000
$1,200,000 - $240,000 FC - 0.75(1,200,000) VC = $60,000 (1 - 0.40) = $36,000.
38. Calculate firm A's degree of operating leverage.

A. 11.0
B. 2.86
C. 9.09
D. 1.00
Based on test bank questions 17.34 and 17.37, DOL = [(60,000 - 30,000)/30,000]/[(1,200,000
- 1,100,000)/(1,100,000) = 1.000/.0909 = 11.0.
Difficulty: Difficult
39. Calculate firm B's degree of operating leverage.

A. .714
B. 9.09
C. 29.86
D. 7.14
Based on test bank questions 17.35 and 17.37, DOL = [(36,000 + 21,000)/21,000]/[(1,200,000
- 1,100,000)/(1,100,000) = 2.7143/.0909 = 29.86
Difficulty: Difficult
17-16
40. Classifying firms into groups, such as _________ provides an alternative to the industry
life cycle.
A. slow-growers
B. stalwarts
C. countercyclicals
D. A and B
E. A and C
The groups in this classification are slow-growers, stalwarts, fast-growers, cyclicals,
turnarounds, and asset plays.
Difficulty: Easy
41. Supply-side economists wishing to stimulate the economy are most likely to recommend
A. a decrease in the money supply.
B. a decrease in production output.
C. an increase in the real interest rate
D. a decrease in the tax rate.
Supply-siders argue that lowering tax rates stimulates investment.
42. Which of the following are not examples of defensive industries?

A. food producers.
B. durable goods producers.
C. pharmaceutical firms.
D. public utilities
E. B and C
B represents a cyclical industry, while the others are examples of defensive industries.
Difficulty: Easy
17-17
43. Which of the following are examples of defensive industries?

A. food producers.
B. durable goods producers.
C. pharmaceutical firms.
D. public utilities
E. A, C and D
B represents a cyclical industry, while the others are examples of defensive industries.
Difficulty: Easy
44. ________ is a proposition that a strong proponent of supply side economics would most
likely stress.
A. Higher marginal tax rates will lead to a reduction in the size of the budget deficit and lower
interest rates as they depend on government revenues.
B. Higher marginal tax rates promote economic inefficiency and thereby retard aggregate
output as they encourage investors to undertake low productivity projects with substantial tax
shelter benefits
C. Income redistribution payments will exert little impact on real aggregate supply as they do
not consume resources directly.
D. A tax reduction will increase the disposable income of households, and thus, the primary
impact of a tax reduction on aggregate supply will stem from the influence of the tax change
on the size of the budget deficit or surplus.
E. None of the above is a likely statement for a supply-side proponent.
Supply-side economists focus on incentives and marginal tax rates.
17-18
45. The industry life cycle is described by which of the following stage(s)?
A. start-up.
B. consolidation.
C. absolute decline.
D. A and B.
E. A, B and C.
The four stages of the industry life cycle are: start-up, consolidation, maturity, and relative
decline.
Difficulty: Easy
46. In the start-up stage of the industry life cycle

A. it is difficult to predict which firms will succeed and which firms will fail.
B. industry growth is very rapid.
C. firms pay a high level of dividends.
D. A and B.
E. B and C.
In the start-up stage, it is very difficult to predict which firms will succeed and which firms
will fail, as no historical data are available. In this stage, industry growth is very rapid (if the
industry is successful) and firms pay little or no dividends.
Difficulty: Easy
47. In the consolidation stage of the industry life-cycle

A. it is difficult to predict which firms will succeed and which firms will fail.
B. industry growth is very rapid.
C. the performance of firms will more closely track the performance of the overall industry.
D. A and B.
E. B and C.
In the consolidation stage of the industry life-cycle the performance of firms will more closely
track the performance of the overall industry.
Difficulty: Easy
17-19
48. In the maturity stage of the industry life cycle

A. the product has reached full potential.
B. profit margins are narrower.
C. producers are forced to compete on price to a greater extent.
D. A and B only.
E. A, B, and C.
In the maturity stage of the industry life cycle the product has reached full potential, profit
margins are narrower, and producers are forced to compete on price to a greater extent.
Difficulty: Easy
49. In the decline stage of the industry life cycle

A. the product may have reached obsolescence.
B. the industry will grow at a rate less than the overall economy.
C. the industry may experience negative growth.
D. A and B only.
E. A, B, and C.
In the decline stage of the industry life cycle the product may have reached obsolescence, the
industry will grow at a rate less than the overall economy, and the industry may experience
negative growth.
Difficulty: Easy
50. A variety of factors relating to industry structure affect the performance of the firm,
including
A. threat of entry.
B. rivalry between existing competitors.
C. the state of the economy.
D. A and C.
E. A and B.
A variety of factors relating to industry structure affect the performance of the firm, including
threat of entry and rivalry between existing competitors.
Difficulty: Easy
17-20
51. The process of estimating the dividends and earnings that can be expected from the firm
based on determinants of value is called
A. business cycle forecasting.
B. macroeconomic forecasting.
C. technical analysis.
D. fundamental analysis.
Fundamental analysis is the analysis of the determinants of value such as earnings prospects.
It includes both macroeconomic analysis and industry analysis.
Difficulty: Easy
52. The emerging market exhibiting the highest growth in real GDP in 2007 was
A. China
B. South Korea
C. Brazil
D. Russia
E. Malaysia
See Table 17.1.
53. The emerging stock market exhibiting the highest U.S. dollar return in 2007 was
A. China
B. Argentina
C. Poland
D. Mexico
E. Brazil
See Table 17.1.
17-21
54. The life cycle stage in which industry leaders are likely to emerge is the
A. start-up stage.
B. maturity stage.
C. consolidation stage.
D. relative decline stage.
E. all of the above.
Industry leaders are most likely to emerge during the consolidation stage, after products
become established.
Difficulty: Easy
55. Investment manager Peter Lynch refers to firms that are in bankruptcy or soon might be
as
A. slow growers.
B. stalwarts.
C. cyclicals.
D. asset plays.
E. turnarounds.
Lynch classifies firms into six categories. Turnarounds may offer tremendous investment
potential if they can recover.
Difficulty: Easy
56. A top-down analysis of a firm's prospects starts with

A. an examination of the firm's industry.
B. an evaluation of the firm's position within its industry.
C. a forecast of interest rate movements.
D. an assessment of the broad economic environment.
E. the application of the CAPM to find the firm's theoretical return.
A top-down analysis first looks at the broad economy, then the industry, then the firm's
position within the industry.
Difficulty: Easy
17-22
57. Over the period 1999-2006, which of the following countries had a change in its real
exchange rate that was favorable for U.S. consumers who want to buy its goods?
A. Canada
B. Italy
C. Germany
D. France
E. Japan
Only Japan had a favorable change. The other countries listed all had negative changes. The
numbers are shown in Figure 17.1.
Difficulty: Easy
58. Over the period 1999-2006, which of the following countries had a change in its real
exchange rate that was most unfavorable for U.S. consumers who want to buy its goods?
A. Canada
B. Italy
C. Germany
D. France
E. Japan
Only Japan had a favorable change. The other countries listed all had negative changes with
Canada being the largest. The numbers are shown in Figure 17.1.
Difficulty: Easy
59. In recent years, P/E multiples have

A. fallen dramatically.
B. risen dramatically.
C. fallen slightly.
D. risen slightly.
E. remained level, on average.
Since 1994 P/Es have risen dramatically as shown in Figure 17.2.
Difficulty: Easy
17-23
60. In recent years, P/E multiples for S&P 500 companies have
A. ranged from -1 to -10.
B. ranged from 1 to 8.
C. ranged from 6 to 10.
D. ranged from 12 to 25.
E. ranged from 20 to more than 50.
Since 1994 P/Es have risen dramatically but fall within the range of 12 to 25 (as shown in
Figure 17.2).
Difficulty: Easy
61. The industry with the highest ROE in 2007 was

A. food.
B. data storage.
C. business software.
D. iron/steel.
E. airlines.
See Figure 17.6.
Difficulty: Easy
62. The industry with the lowest ROE in 2007 was

A. food.
B. data storage.
C. business software.
D. iron/steel.
E. airlines.
See Figure 17.6.
Difficulty: Easy
17-24
63. The industry with the lowest return in 2007 was

A. home construction.
B. oil equipment.
C. health care.
D. brokerage.
E. banking.
See Figure 17.7.
Difficulty: Easy
64. The industry with the highest return in 2007 was

A. home construction.
B. oil equipment.
C. health care.
D. brokerage.
E. banking.
See Figure 17.7.
Difficulty: Easy
65. Investors can ______ invest in an industry with the highest expected return by purchasing
______.
A. most easily; industry-specific iShares
B. not; industry-specific iShares
C. most easily; industry-specific ADRs
D. not; individual stocks
Investors can most easily invest in an industry with the highest expected return by purchasing
industry-specific iShares.
Difficulty: Easy
17-25
66. Which of the following are key economic statistics that are used to describe the state of
the macroeconomy?
I) gross domestic product
II) the unemployment rate
III) inflation
IV) consumer sentiment
V) the budget deficit
A. I, II, and V
B. I, III, and V
C. I, II, and III
D. I, II, III, and V
E. I, II, III, IV, and V
All of the factors are key economic statistics.
Difficulty: Easy
67. An example of a positive demand shock is

B. a decrease in government spending.
C. a decrease in foreign export demand.
D. a decrease in the price of imported oil.
E. a decrease in tax rates.
Increases in the items mentioned in answers A, B, and C would be favorable demand shocks.
Imported oil price changes are supply shocks. A decrease in tax rates is the only favorable
demand shock mentioned.
Difficulty: Easy
17-26
68. An example of a negative demand shock is

B. a decrease in government spending.
C. an increase in foreign export demand.
D. a decrease in the price of imported oil.
E. A and B.
Increases in the items mentioned in answers A, B, and C would be favorable demand shocks.
Imported oil price changes are supply shocks. A decrease in tax rates is the only favorable
demand shock mentioned.
Difficulty: Easy
69. During which stage of the industry life cycle would a firm experience stable growth in
sales?
A. Consolidation
B. Relative Decline
C. Maturity
D. Start-up
E. Stabilization
One of the features of the Consolidation phase is stable growth. There is no "Stabilization"
stage. During Start-up there is rapid growth; during the Maturity phase there is slowing
growth; and during the Relative Decline phase there is minimal or negative growth.
Difficulty: Easy
70. The emerging stock market exhibiting the highest local currency return in 2007 was
A. Russia
B. China
C. Poland
D. Mexico
E. China
See Table 17.1.
17-27
71. Sector rotation

A. should always be carried out.
B. is never worthwhile.
C. is shifting the portfolio more heavily toward an industry or sector that is expected to
perform well in the future.
D. can be implemented costlessly.
Sector rotation is shifting the portfolio more heavily toward an industry or sector that is
expected to perform well in the future.
Difficulty: Easy
72. According to Michael Porter, there are five determinants of competition. An example of
_____ is when new entrants to an industry our pressure on prices and profits.
A. Threat of Entry
B. Rivalry between Existing Competitors
C. Pressure from Substitute Products
D. Bargaining power of Buyers
E. Bargaining power of Suppliers
According to Michael Porter, there are five determinants of competition. An example of
Threat of Entry is when new entrants to an industry our pressure on prices and profits.
Difficulty: Easy
17-28
_____ is when competitors seek to expand their share of the market.
A. Threat of Entry
Rivalry between Existing Competitors is when competitors seek to expand their share of the
market.
Difficulty: Easy
_____ is when the availability limits the prices that can be charged to customers.
A. Threat of Entry
Pressure from Substitute Products is when the availability limits the prices that can be charged
to customers.
Difficulty: Easy
17-29
_____ is when a buyer purchases a large fraction of an industry's output and can demand price
concessions.
A. Threat of Entry
Bargaining power of Buyers is when a buyer purchases a large fraction of an industry's output
and can demand price concessions.
Difficulty: Easy
76. Assume the U.S. government was to decide to increase the budget deficit. This action will
most likely cause __________ to increase
A. interest rates
C. unemployment
D. both A and B
Decreasing the deficit lowers government borrowing, decreases the demand for funds and
thus decreases the interest rates. Increasing the deficit does the opposite.
Difficulty: Easy
17-30
77. If interest rates decrease, business investment expenditures are likely to ______ and
consumer durable expenditures are likely to _________.
E. be unaffected, be unaffected.
As interest rates decrease, it becomes less expensive for businesses to increase their
investment expenditures and the more durable goods produced become less expensive.
78. An example of a defensive industry is ________.

A. the automobile industry
B. the tobacco industry
C. the food industry
D. A and B
E. B and C
Consumer durables, such as automobiles, are highly cyclical as purchases can be delayed until
good times. Necessities, low-ticket items, and addictive products are purchased in good times
and bad.
Difficulty: Easy
Two firms, C and D, both produce coat hangers. The price of coat hangers is $1.20 each.
Firm C has total fixed costs of $750,000 and variable costs of 30 cents per widget. Firm D has
total fixed costs of $400,000 and variable costs of 50 cents per widget. The corporate tax rate
is 40%. If the economy is strong, each firm will sell 2,000,000 widgets. If the economy enters
a recession, each firm will sell 1,400,000 widgets.
17-31
79. If the economy enters a recession, the total revenue of Firm C will be ________.
A. $1,680,000
B. $1,400,000
C. $2,000,000
D. $0
$1,400,000(1.20) = $1,680,000
80. If the economy enters a recession, the total cost of Firm C will be ________.
A. $1,680,000
B. $1,170,000
C. $750,000
D. $420,000
$1,400,000(.30) +750,000 = $1,170,000
81. If the economy enters a recession, the before tax profit of Firm C will be ________.
A. $1,680,000
B. $1,170,000
C. $510,000
D. $204,000
$1,680,000 - 1,170,000 = 510,000 (see response to questions 67 and 68)
17-32
82. If the economy enters a recession, the tax of Firm C will be ________.
A. $1,680,000
B. $750,000
C. $510,000
D. $204,000
$510,000(.4) = 204,000 (see response to question 69)
83. If the economy enters a recession, the after tax profit of Firm C will be ________.
A. $1,680,000
B. $750,000
C. $510,000
D. $204,000
E. $306,000
$510,000 - 204,000 = 306,000 (see response to questions 69 and 70)
84. If the economy is strong, the total revenue of Firm C will be ________.
A. $1,680,000
B. $1,400,000
C. $2,000,000
D. $2,400,000
$2,000,000(1.20) = $2,400,000
17-33
85. If the economy is strong, the total cost of Firm C will be ________.
A. $1,680,000
B. $1,170,000
C. $1,305,000
D. $420,000
$2,000,000(.30) + 750,000 = $1,350,000
86. If the economy is strong, the before tax profit of Firm C will be ________.
A. $1,680,000
B. $1,050,000
C. $510,000
D. $204,000
$2,400,000 - 1,350,000 = 1,050,000 (see response to questions 72 and 73)
87. If the economy is strong, the tax of Firm C will be ________.

A. $420,000
B. $750,000
C. $510,000
D. $204,000
$1,050,000(.4) = 420,000 (see response to question 74)
17-34
88. If the economy is strong, the after-tax profit of Firm C will be _______.
A. $0
B. $6,000
C. $36,000
D. $60,000
E. $630,000
$1,050,000 - 420,000 = 630,000 (see response to questions 74 and 75)
89. If a firm's sales decrease by 15% and profits decrease by 20% during a recession, the
firms operating leverage is ____________?
A. 1.33
B. 0.75
C. 5
D. -5
-20/-15 = 1.33
17-35
Short Answer Questions

90. Discuss the tools of the U.S. government's "demand-side" policy. Include in your
discussion of these tools the relative advantages and disadvantages of each in terms of the
effect of the use of these tools on the economy.
The two tools of the government's "demand-side" policy are fiscal and monetary policy. Fiscal
policy is the use of government spending and taxing for the specific purpose of stabilizing the
economy. Fiscal policy, once enacted, has the most direct and immediate effect on the
economy. However, the formulation and implementation of fiscal policy is extremely slow, as
such policy must be approved by both the legislative and executive branches of the federal
government. Monetary policy consists of actions taken by the Board of Governors of the
Federal Reserve System (FRS) to influence the money supply and/or interest rates. Monetary
policy is relatively easy to formulate and to implement, but has less direct impact on the
economy than fiscal policy. The most widely used tool of the FRS is the open market
operations, in which the Fed buys or sells bonds for the Fed's account. Buying securities
increases the money supply; selling securities decreases the money supply. Open market
operations occur daily. Other FRS tools include adjusting the discount rate, which is the
interest rate the Fed charges banks on short-term loans, and altering reserve requirements,
which are the fraction of deposits that banks must maintain in cash deposits with the Fed.
Reductions in the money supply signal an expansionary monetary policy; lowering reserve
requirements increase the money supply, and thus, stimulate the economy. The Fed walks a
fine line: expansionary monetary policy probably will lower interest rates and stimulate
investment and consumption in the short run, but ultimately inflation probably will result.
Feedback: The rationale of this question is to ascertain whether the student has an
understanding of the basic principles of macroeconomics.
17-36
91. Discuss the National Bureau of Economic Research (NBER)'s indexes of economic
indicators, and how each of the categories of these indicators might be used by the securities'
analyst.
The NBER has developed a set of cyclical indicators to help forecast, measure, and interpret
short-term fluctuations in economic activity. The leading economic indicators are those that
tend to increase or decrease in advance of the rest of the economy. These indicators are used
to forecast the state of the economy for the coming period (usually one year). Coincident
economic indicators move in tandem with the broad economy, and are used to confirm (or
disconfirm) an earlier economic prediction. Lagging economic indicators are those that move
after the broad economy, and are used to identify the end of a stage of the business cycle (such
as a trough) and as an indication that another stage of business cycle (such as the expansion)
is about to begin. The S&P 500 stock index is an excellent leading economic indicator, as
would be expected by market efficiency proponents. However, if the stock market anticipates
general economic trends, the task of the fundamentalist using economic forecasts to identify
attractive industries (and thus stocks) for the future becomes even more impossible.
Feedback: The purpose of this question is to ascertain the student's understanding of the
widely quoted economic indicators and the usefulness (and lack thereof) in securities'
analysis.
17-37
92. Discuss the industry life cycle, how this concept can be used by security analysts, and the
limitations of this concept for security analysis.
The industry life cycle may be defined by the following stages: start up (rapid and increasing
growth), consolidation (sable growth), maturity (slowing growth), and relative decline
(minimal or negative growth). Investors interested in identifying new, and presumably
ultimately successful, industries will use this technique, trying to get in on the "ground floor".
In the start up stage, no historical data is present; thus, one cannot identify potentially
successful firms. However, typically, all of the firms are selling at low prices and the investor
will "diversify across the industry" by buying many different stocks in the industry. If the
industry becomes successful, the surviving firms will appreciate substantially in value; the
non-surviving firms will be written off as losses. Typically, in this stage, firms are paying little
or no dividends. Investment in this stage is for the risk-tolerant investor. As the industry
moves from the start up to the consolidation stage, firms begin paying or increasing
dividends; the surviving firms become more successful, begin to enjoy economies of scale,
and are moving up the learning curve in terms of cost efficiency. In the maturity stage, the
growth has slowed and dividends may have increased; less risk is involved. By the relative
decline stage, the firm has no new exciting capital budgeting projects and may have become
an "income stock", by paying out a higher than average level of dividends. At this stage, the
stock may be attractive for the risk-averse retiree interested in dividend income. However, the
stock must be watched carefully in this stage, as this industry may be dying (buggy whips).
However, over the industry life cycle, the clientele for the firms' stocks have changed, from
the risk-tolerant to the risk averse.
The problem with using this concept for investment purposes is identifying where the industry
is in the industry life cycle. In addition, all industries do not move through the cycle in the
same fashion. In fact, the goal is to avoid the relative decline stage.
Feedback: The purpose of this question is to ascertain whether the student understands the
industry life cycle, how the concept can be used by investors, and the limitations of the
concept for investors.
17-38
93. Discuss the ways in which the global economy might have an effect on a firm whose
headquarters are in Montana. Be specific - cite some of the relevant factors that should be
considered.
A firm that operates from Montana cannot ignore the global economy. The firm may make
sales to other countries, employ people from other countries, and invest in other countries. It
may face price competition from similar firms abroad, be subject to wages that are different
from those paid by foreign firms, and management may have less power to do what it wants
due to labor unions. Exports of its products and imports will be influenced by the global
economy. Interest rates in other countries will determine part of the return on the firm's
investments. Exchange rates pose an additional risk if the company wants to repatriate its
earnings. Countries' political and economic policies should be considered, with some being
more predictable than others. Global markets have some linkages, but there are significant
variations in performance among countries.
Feedback: This question emphasizes the importance of the global economy, which should not
be ignored when doing a macroeconomic analysis.
Difficulty: Easy
17-39
94. List and discuss three of the five determinants of competition suggested in Porter's 1985
study.
The determinants are: the threat of entry from new competitors, rivalry between existing
competitors, price pressure from substitute products, the bargaining power of buyers, and the
bargaining power of suppliers. Each of these is discussed below.
Threat of entry from new competitors - If there are high profit margins in the industry, new
competitors will be likely to enter. There may be some barriers to entry that existing firms can
establish to discourage this. Possible barriers include longstanding relationships with suppliers
and buyers, proprietary knowledge or patents, brand loyalty, and experience in the market.
Rivalry between existing competitors - This could lead to price competition and lower profit
margins. Expansion of one firm cuts into the rivals' market shares. Firms with homogeneous
products face price pressure because they are unable to differentiate their products from their
competitors' products. High fixed costs might force a company to operate at close to full
capacity.
Price pressure from substitute products - If firms in related industries produce similar
products, the firm may not be able to charge as much for its product. Some examples are
carbonated beverages and fruit drinks, paint and wallpaper, and movies and videos. Many
other examples may be offered.
Bargaining power of buyers - Buyers might have bargaining power if they purchase a
substantial proportion of the firm's output. The firm might have to settle for accepting a lower
price for its products. The automobile industry is an example given in the textbook.
Bargaining power of suppliers - If the firm depends on a supplier to provide much of its
inputs, the supplier might demand a higher price. This is especially true if there are no easily
available alternative suppliers. Labor unions are cited as an example.
Feedback: This question tests the student's understanding of the relationships among industry
structure, competitive strategy, and profitability.
17-40

Chap 017

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Chap 017

Uploaded by

Copyright:

Available Formats

Chapter 17 - Macroeconomic and Industry Analysis

2. An example of a highly cyclical industry is ________.

Chapter 17 - Macroeconomic and Industry Analysis

3. Demand-side economics is concerned with _______.

4. The most widely used monetary tool is ___________.

5. The "real", or inflation-adjusted, exchange rate, is

Chapter 17 - Macroeconomic and Industry Analysis

7. Monetary policy is determined by

Chapter 17 - Macroeconomic and Industry Analysis

Chapter 17 - Macroeconomic and Industry Analysis

14. Industrial production refers to _________.

Chapter 17 - Macroeconomic and Industry Analysis

15. GDP refers to _________.

Chapter 17 - Macroeconomic and Industry Analysis

Chapter 17 - Macroeconomic and Industry Analysis

Chapter 17 - Macroeconomic and Industry Analysis

Chapter 17 - Macroeconomic and Industry Analysis

Chapter 17 - Macroeconomic and Industry Analysis

29. The North American Industry Classification System (NAICS)

Chapter 17 - Macroeconomic and Industry Analysis

Chapter 17 - Macroeconomic and Industry Analysis

Chapter 17 - Macroeconomic and Industry Analysis

32. Fiscal policy is difficult to implement quickly because

Chapter 17 - Macroeconomic and Industry Analysis

Chapter 17 - Macroeconomic and Industry Analysis

38. Calculate firm A's degree of operating leverage.

39. Calculate firm B's degree of operating leverage.

Chapter 17 - Macroeconomic and Industry Analysis

42. Which of the following are not examples of defensive industries?

Chapter 17 - Macroeconomic and Industry Analysis

43. Which of the following are examples of defensive industries?

Chapter 17 - Macroeconomic and Industry Analysis

46. In the start-up stage of the industry life cycle

47. In the consolidation stage of the industry life-cycle

Chapter 17 - Macroeconomic and Industry Analysis

48. In the maturity stage of the industry life cycle

49. In the decline stage of the industry life cycle

Chapter 17 - Macroeconomic and Industry Analysis

Chapter 17 - Macroeconomic and Industry Analysis

56. A top-down analysis of a firm's prospects starts with

Chapter 17 - Macroeconomic and Industry Analysis

59. In recent years, P/E multiples have

Chapter 17 - Macroeconomic and Industry Analysis

61. The industry with the highest ROE in 2007 was

62. The industry with the lowest ROE in 2007 was

Chapter 17 - Macroeconomic and Industry Analysis

63. The industry with the lowest return in 2007 was

64. The industry with the highest return in 2007 was

Chapter 17 - Macroeconomic and Industry Analysis

67. An example of a positive demand shock is

Chapter 17 - Macroeconomic and Industry Analysis

68. An example of a negative demand shock is

Chapter 17 - Macroeconomic and Industry Analysis

71. Sector rotation

Chapter 17 - Macroeconomic and Industry Analysis

Chapter 17 - Macroeconomic and Industry Analysis

Chapter 17 - Macroeconomic and Industry Analysis

78. An example of a defensive industry is ________.

Chapter 17 - Macroeconomic and Industry Analysis

Chapter 17 - Macroeconomic and Industry Analysis

Chapter 17 - Macroeconomic and Industry Analysis

87. If the economy is strong, the tax of Firm C will be ________.

Chapter 17 - Macroeconomic and Industry Analysis