FIN 402 Week 1: Textbook Case Problems

Textbook Case Problems Week 1

FIN/402

1.2

Assume that Carolyn places currently available funds in the savings account. Determine the amount of money Carolyn will have available at retirement once she sells her house if she retires at (1) age 62 and (2) age 65.

Retires at 62 (7-year investment):

$97,500*(1.06)^7+selling price of house = $146,640 + $112,500(house) = $259,140

Retires at 65 (10-year investment):

$97,500*(1.06) ^10+selling price of house = $174,622.50 + $127,500(house) = $302,122.50

Using the results from item a, determine the level of annual income that will be provided to Carolyn through purchase of an annuity at (1) age 62 and (2) age 65.

Value of Carolyn’s assets at 62 = value of savings account + value of house

Value of Assets at 62 = $146,640 + $112,500 = $259,140

Value of Assets at 65 = $174,622.50 + $127,500 = $302,122.50

Carolyn’s annual income at 62 would be $259,140 / 12.659 = $20,470.81

Carolyn’s annual income at 65 would be $302,122.50 / 11.118 = $27,174.17

With the results found in the preceding questions, determine the total annual retirement income Carolyn will have if she retires at (1) age 62 and (2) age 65.

From your findings, do you think Carolyn will be able to achieve her long-run financial goal by retiring at (1) age 62 or (2) age 65? Explain.

Carolyn needs $45,000 per year, before taxes, of retirement income. Without considering the change in her tax status with retirement, she will not satisfy this goal if she chooses to retire at 62. At age 65 she would meet this requirement.

Evaluate Carolyn’s investment plan in terms of her use of a savings account and an annuity rather than other investments. Comment on the risk and return characteristics of her plan. What recommendations might you offer Carolyn? Be specific.

The investment plan that Carolyn has is conservative and low risk. The returns from the plan are secure and seem to be assured. Carolyn can be confident that her investments will be available when she does retire. The plan to retire at 65 would meet her retirement income goal. Her current plan is low risk and low return, so if she slightly increases the risk, she could improve the return on her investments. Carolyn could purchase CDs or highly rated bonds to help earn higher returns on her investments.

2.1

Evaluate each of these alternatives. On the basis of the limited information presented, recommend the one you feel is best.

-It’s important to consider taxes when evaluating the four alternatives – approximately 11% of the current $54 price would go to taxes if sold this year rather than next.

-The unpredictability of the stock price, as there is a large swing in price, as well as, Dara’s attitude towards risk, as she seems to be risk adverse.

-NewestHighTech.com is a new and small company in the technology sector.

-The stocks of this new technology sector grew at a high rate.

-This company will potentially grow at a high rate, thus making this a better option for investing in the upcoming public offer.

Alternative 1 is the best option.

If Casinos International’s stock price rises to $60, what will happen under alternatives 2 and 3? Evaluate the pros and cons of these outcomes.

Since the current market price of stock is $54, with a move to $60 it would cause stock holders to earn capital gain, while short tellers would lose.

Alternative 2: Investors would earn capital gain of $6 per share on Casino International stocks

Alternative 3: Investors would have a loss of $6 per share on Casino International stocks

A pro would be that invested capital would increase, while a con would be that the investor would have to pay $6 more per share when buying the stock.

If the stock price drops to $45, what will happen under alternatives 2 and 3? Evaluate the pros and cons of these 

With alternative 2, it is a long purchase so a decrease in the stock would result in a loss.

Alternative 3, on the other hand, is an example of short selling, meaning that the drop in price would result in a gain.

2.2

Discuss the concept of pyramiding as it applies to this investment situation.

With this situation, Ravi is planning to buy stock from paper profits in margin accounts, which is pyramiding.

What is the present margin position (in percent) of Ravi’s account?

Margin = V- D/V = $75,000 – $30,000 / $75,000 = .60 = 60%

Ravi buys the 1,000 shares of RS through his margin account (bear in mind that this is a $20,000 transaction).

What will the margin position of the account be after the RS transaction if Ravi follows the prevailing initial margin (50%) and uses $10,000 of his money to buy the stock?InitialNew Purchase= Total Account

Value of securities$75,000$20,000$95,000

Debit Balance$30,000$10,000$40,000

Equity$45,000$10,000$55,000

Meaning, the new margin in account = $55,000 / $95,000 = 57.90%

What if he uses only $2,500 equity and obtains a margin loan for the balance ($17,500)?InitialNew Purchase=Total Account

Value of securities$75,000$20,000$95,000

Debit balance$30,000$17,500$47,500

Equity$45,000$2,500$47,500

Meaning, the new margin in account = $47,500 / $95,000 = 50%

How do you explain the fact that the stock can be purchased with only 12.5% margin when the prevailing initial margin requirement is 50%?

Ravi is able to purchase the stock referenced above with only 12.5% margin ($2,500/$20,000) since the margin requirements are on the account rather than the transaction. If he has excess margin in the account, then new purchases are able to be made with transaction margin percentages below the initial requirement.

Assume that Ravi buys 1,000 shares of RS stock at $20 per share with a minimum cash investment of $2,500 and that the stock does take off and its price rises to $40 per share in one year.

What is the return on invested capital for this transaction?

Return on invested capital

= $0 – ($17,500 * .10) + ($40 * 10,000) – ($20 * 1,000) / $2,500

= $0 – $1,750 + $40,000 – $20,000 / $2,500 = 730%

What return would Ravi have earned if he had bought the stock without margin—that is, if he had used all his own money?

= 20,000 / 20,000 = 100%

What do you think of Ravi’s idea to pyramid? What are the risks and rewards of this strategy?

Pyramiding helps Ravi to leverage his profits by using the paper profits to buy additional shares. The reward would be that Ravi gets large returns if the stock appreciates the way he anticipates. The risk would be if the stock does not appreciate, the margin would be insufficient sooner as he had a margin of only 12.5% for the transaction.

3.1

Explain what role the Wall Street Journal and/or Barron’s might play in meeting Angel’s needs. What other general sources of economic and current event information would you recommend to Angel? Explain.

With Angel wanting to concentrate on stocks and bonds, the Wall Street Journal and Barron’s are the best sources of information. The Wall Street Journal is published daily with price quotations on thousands of securities; it also provides world, national, and corporate news. Barron’s is published weekly with articles that are interesting. It also has price quotations and also provides the readers with a summary of statistics for several investment vehicles.

How might Angel be able to use the services of Standard & Poor’s Corporation, Mergent, and the Value Line Investment Survey to learn about the securities in the portfolio? Indicate which, if any, of these services you would recommend, and why.

I believe that Standard & Poor’s Corporation would be best for him because it is very reputable. Any of these options would be viable for the same reasons as above. It is common for these companies to be unbiased, which is beneficial because they do not influence you to buy or sell shares of stocks.

Recommend some specific online investment information sources and tools to help Angel and Marie manage their investments.

I believe that Fidelity is one of the best options for an online investment tool. Fidelity is a trusted and reputable option when it comes to investing online tools. They have a mobile app which allows you to stay up to date on stocks and your accounts easily, no matter where you may be. It keeps you up to date on current stock prices, along with the percentage changes for the market day. It is also helpful when you want to gather more information about a specific stock.

Explain to Angel the need to find a good stockbroker and the role the stockbroker could play in providing information and advice. Should he consider hiring a financial advisor to manage the portfolio?

Stockbroker’s are considered the experts when it comes to this field, as they deal with stocks daily. Having an expert on your side is beneficial because they are able to notice trends and understand them better than the average person. It is always a good idea to hire a financial advisor to manage your portfolio because they can focus on it more than you are able to. In Angel’s case, he would still be able to manage how his portfolio is broken down, but with the help of an expert.

Give Angel a summary prescription for obtaining information and advice that will help to ensure the preservation and growth of the family’s newfound wealth.

It is most important that Angel do a great deal of research on the inherited portfolio. To ensure that he and Marie know what to do in the future, it is critical to become familiar with the current standings of the portfolio. It would also be a great idea for Angel to seek help of a professional to learn about all of his different options. Once Angel finds a professional that he is comfortable with, it is a good idea for him to hire that person to help oversee his financials, thus allowing him to increase profits for his family.

12.1

In light of Mark’s long-term investment goals, do you think mutual funds are an appropriate investment vehicle for him?

With Mark’s long term investment goals, I believe that mutual funds would be a great idea. The reason for this is because mutual funds are diversified and Mark is able to choose the risk level he is comfortable with. Mutual funds also allow the individual to invest as little or as much as they would like. With Mark only having $250 each quarter at his disposal, this option would be low risk and a great choice.

Do you think he should use his $15,000 savings to start a mutual fund investment program?

It would be a good idea for Mark to use his $15,000 in savings to start a mutual fund because he would get a better return in the investment portfolio than he does by keeping this in a savings account. It is common that when setting up a mutual fund you have to start with a large sum up front followed by smaller installments, thus making this a great option.

What type of mutual fund investment program would you set up for the reverend? Include in your answer some discussion of the types of funds you would consider, the investment objectives you would set, and any investment services (e.g., withdrawal plans) you would seek. Would taxes be an important consideration in your investment advice? Explain.

I would recommend a balanced fund for the reverend since he needs to save for retirement as well as a college fund for his young child. The reason for a balanced fund is because it generates a balanced return on both income and capital gains. It would also be a good idea for the reverend to have a financial advisor help him with his financial journey because they could be a good source to help guide him in the right direction for the needs he is wanting to meet.