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CFA Level I · CFA Level I Exam · Relative Value Equity Valuation Approaches

An analyst values a company in a country with a much higher risk-free rate and inflation than the country of its peer group, using the P/E ratios of the peers. The P/E ratio of the company is most likely to be:

The company's P/E is most likely lower than peers, all else equal, because higher inflation and risk-free rates raise the required return on equity. A higher discount rate reduces the justified multiple unless real growth offsets it, so peer multiples from lower-rate countries overstate value.

  1. Alower than peers, all else equal, because of the higher required returnCorrect
  2. Bhigher than peers, all else equal, because of nominal earnings growth
  3. Cidentical to peers, because multiples are independent of country

Explanation

A higher risk-free rate and inflation raise the required return on equity, which increases the discount rate applied to earnings. Unless offset by higher real growth, this lowers justified P/E. Multiples are not independent of country factors.

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