Week 3 Problems
FIN/402
Case Problem 6.1 A-C (page 252)
Savings accounts are a safe way to keep money and earn interest but if she is willing to take on more risk she is better off investing in stocks. By holding diversified common stock (or mutual fund), she can have to opportunity to earn higher returns.
North Atlantic Swim Suit Company is risky, but I would have to look at their overall performance to make a decision. They can be a smaller company that is still emerging and Sara has some risk tolerance.
Town and Country Computer, seems low risk, with a consistent modest return
Southeastern Public Utility Company, consistent performance with a small but steady dividend yield.
International Gold Mines, Inc., this is a good option to add to a diverse portfolio and can potential result in large capital gains.
Overall these choices are a good fit for Sara.
Sara already has an established job and makes a good salary. Her savings was just sitting in an account and she is interested in bumping up her returns. Her investment portfolio can become more of a retirement fund because there is not mention of one. In that case a quality long-term approach would be suitable for her.
Case Problem 6.2 A-C (page 252)
Wally’s present investment program is a quality long-term growth strategy. Taking his income, knowledge and the time he has to devote to trading, his objective seems to be in line with his strategy.
Earnings
| Year | Expected Annual Dividend |
|---|---|
| 2016 | $1.30 |
| 2017 | $1.36 |
| 2018 | $1.76 |
| 2019 | $1.98 |
| 2020 | $2.25 |
Wally will realize $2,865.00 which represent $2,000 from the change in the stock price and a total of $865 in dividends paid.
Wally will have a total of 114.26 stocks with a total value of $9,140.65. The amount of stock purchased through the DRIP alone will be worth $1,140.65.
Wally is changing the security of his investment but not his strategy. If anything he would incur some investment fees with his broker. It would be prudent for Wally to occasionally keep up with his portfolio.
Case Problem 7.1 A-C (page 293)
A.
| Liquidity |
|---|
| A – Net working capital = Current assets – Current liabilities |
| = $21,250 – $10,000 = $11,250 |
| B – Current ratio = Current assets/Current liabilities |
| = $21,250/$10,000 = 2.12 |
| Activity |
| C – Receivables turnover = Sales/Accounts receivable |
| = $50,000/$8,000 = 6.25 |
| D – Inventory turnover = Sales/Inventory |
| = $50,000/$12,000 = 4.17 |
| E – Total asset turnover = Sales/Total assets |
| = $50,000/$30,000 = 1.67 |
| Leverage |
| F- Debtequity ratio = Longterm debt/Stockholder’s equity |
| = $8,000/$12,000 = 0.67 |
| G – Times interest earned = Earnings before interest and taxes/interest |
| = $10,000/$2,500 = 4.0 |
| Profitability |
| H – Net profit margin = Net profits after taxes/Sales |
| = $5,000/$50,000 = 1 or 10% |
| I – Return on total assets = Net profits after taxes/Total assets |
| = $5,000/$30,000 = 0.166 or 16.67% |
| J – Return on equity = Net profits after taxes/Stockholder equity |
| = $5,000/$12,000 = 0.4167 or 41.67% |
| Common Stock Ratios |
| K – Earnings per share = (Net profits after taxes – Preferred dividends) |
| /# of shares of common stock outstanding |
| = $5,000 – 0/5,000 = $1/share |
| L – Price/Earnings ratio = Share price/EPS |
| = $25/$1 = 25 times |
| M – Dividends per share = Total common dividends paid/ |
| Common shares outstanding |
| = $1,250/5,000 = $0.25/sh. |
| N – Dividend yield = Dividends per share/Share price |
| = $0.25/$25.00 = 0.01 or 1% |
| O – Payout ratio = Dividends per share/EPS |
| = $ 0.25 / $1.00 = 0.25 or 25% |
| P – Book value per share = Common equity/Common shares outstanding |
| = $12 million/5 million = $2.40 |
| Q – Pricetobook value = Share price/Book value per share |
| = $25/$2.40 = 10.42B.A – South Plains is more liquidB – Weakness – low ratios compared to industryC – Higher debt utilization that the industry average and lower ability to cover interest that industry averageD – Higher margins and high ROE that industry average but lower return on assetsE – Earnings and Price ratios are higher that industry average yet dividend rations are lowC.The ratios for the company is very promising. Jack has adequate knowledge to make this a confident selection. |
Case Problem 7.2 A-C (page 294)
The three most important factors are cost of oil, interest rates and consumer spending.
Auto imports – Less money is return domestically when imports are sold in the U.S.
The United Auto Workers union – problems with the union can lead to strikes and other negative events that can cause a rise in production costs
Interest rates – When interest rates are higher, less vehicles will be sold.
The price of a gallon of gas – Higher gas prices affect the sales of SUVs and other case with lower MPG. However, higher gas prices can influence an increase in hybrid sales.
Sales = 1.5 x $25 Billion = $37.5 Billion
Net profits after taxes = 0.15 x 37.5 Billion = $5.625 Billion
Current ratio = 8.4 Billion / 5 Billion = 1.68
Market price of the stock = 12.5 x $3.00 = $37.50
Dividend yield = $3.00 x 0.4 = $1.20
Case Problem 8.1 A-B (page 332
| Y1 | Y2 | Y3 | |
| Sales | $22,500,000 | $35,000,000 | $50,000,000 |
|---|---|---|---|
| Net Profit Margin (20%) | 0.20 | 0.20 | 0.20 |
| Net Profit | $4,500,000 | $7,000,000 | $10,000,000 |
| Number of Shares | 2500000 | 2500000 | 2500000 |
| Earnings Per Share | $1.80 | $2.80 | $4.00 |
Y3 40 x 40 = $160
| # of Shares | 1000 | 1000 | |
|---|---|---|---|
| Market Value | $70,000 | $160,000 | |
| ROI | 0.4375 |
The market can be volatile meaning it may have potential significant losses.
Yes, as long as the expected return meets or exceeds his desired return.
Putting all his money into one fund might sound good with the potential of earing a big return but can end in disaster. Chris should consider diversification.
Chris can invest half of his money into that stock if he feels that strongly about. He can also look into safer alternatives.
Foreign markets can be risky and hard to get to but can earn large yields. Chris has the capital and experienced broker needed to reach the foreign markets prudently.
Case Problem 8.2 A-B (page 333)
| Year | Sales ($ millions) | Grown Rate |
|---|---|---|
| 2011 | $7.5 | |
| 2012 | $10.0 | 33.33% |
| 2013 | $12.5 | 25.00% |
| 2014 | $16.20 | 29.60% |
| 2015 | $22.0 | 35.80% |
| 2016 | $28.5 | 29.55% |
| Avg | 30.66% |
Use this average growth rate to forecast revenues for next year (2017) and the year after that (2018).
| Expected Sales | Sales ($ millions) |
|---|---|
| 2017 | $37.24 |
| 2018 | $48.65 |
Now determine the company’s net earnings and EPS for each of the next two years (2017 and 2018).
| Expected Sales | Sales ($ millions) | Net Sale | EPS |
|---|---|---|---|
| 2017 | $37.24 | $4.47 | $0.89 |
| 2018 | $48.65 | $5.84 | $1.17 |
Finally, determine the expected future price of the stock at the end of this two-year period.
| Expected Sales | P/E Ratio | Stock Price |
|---|---|---|
| 2017 | 35 | $31.28 |
| 2018 | 50 | $58.38 |
Marc should invest in this stock if he plans on holding it for longer than a year. The data collected suggests the stock price will rise to $58.38
Case Problem 9.2 A-C (page 374)
Period 1= 5.30% ÷ 6.50%= 0.8154 X 100 = 81.54%
Period 2 = Yield on Dow Jones average of 40 corporate bonds= 5.70% + (155÷100) = 7.25%
Confidence index= 5.70% ÷ 7.25%= 0.7862 X 100 = 78.62%
Period 3 Confidence index= 5.10% ÷ 6.00%= 0.85 X 100 = 85%
Period 4 Average yield on 10 high-grade corporate bonds= 4.90% – (25÷100) = 4.65%
Confidence index= 4.65% ÷ 4.90%= 0.9489 X 100 = 94.89%
| Period 0 | |
| Average yield on 10 high-grade corporate bonds | 5.60% |
| Yield on Dow Jones average of 40 corporate bonds | 6.45% |
| Yield spread | 85 |
| Confidence index | 86.83% |
Bonds went up from 0 to period 2 and then decreases the next two periods. The confidence index did the opposite in those years. Period 2 is the bearish period and period 4 was bullish.
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