Please describe the methodological approach that should be used to value AirThread

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1. Please describe the methodological approach that should be used to value AirThread (should Ms. Zhang use WACC, APV, or some combination thereof). How should the cash flows be valued for 2008 through 2012? How should the terminal value or going concern be estimated? How should the nonoperating investments in equity affiliates be accounted for in the valuation? [Hint: it may be possible to use more than one technique simultaneously] 2. What discount rate should Ms. Zhang use for un-levered FCF for 2008 through 2012? Is this the same discount rate that should be used to value the terminal value? Why or why not 3. Develop an estimate of the long-term growth rate that should be used to estimate AirThread’s terminal value. Using your estimate of long-term growth, what is the present value of the AirThread’s going concern value? 4. What is the total value of AirThread before considering any synergies? What is the value of AirThread, assuming Ms. Zhang’s estimates for synergies are accurate?

Question 1

Considering the case analysis, AirThread communication will be acquired by American Cable Communication. They will however accrue a huge amount of liabilities in form of debts which will attract a long-term repayment scheme, this is a normal event in the industry however. Considering the Leverage Buyout approach, American Cable will have increased capital. This form of event will point towards a purchase financed by a debt. With such a scenario, the only possible way of determining the Value of Airthread will involve the use of WACC. This will call for Ms. Zhang to employ WACC and APV to estimate the target.

The APV value is important in evaluating the value of the target. It will be employed by issuing discount values to the free cash flow of 2008 to 2012.

Another significant use of WACC is to determine the terminal value of the target when ATC increases at a constant rate for the perpetual. In this scenario, an assumption of the growth is considered.

Question 2.

It can be observed and concluded that ACC will pay down the debt slowly over time. The debt bears a depreciating value, in this regard, APV method will be best suited for making calculations.

The International, Tax Shield is calculated using the expression: VL=VU+PV

Thus, it is advisable to independently determine the two variables by employing the different discount rates. Here, rA is the discount rate used to find the desired parameters and VU and rD. Are discount rate used to calculate PV (Int. Tax Shields).

It is not advisable for Ms. Zhang to use same discount values for the terminal values. . The discount rate for the terminal value should make use of WACC. The foundation is that ATC will not preserve its debt to equity ratio during 2008 to 2012, this explains why it is not necessary employing WACC as the discount rate. Beyond 2012, we assume the company will propagate with a constant rate which means it will grow in a perpetual design.

Thus:

Question 3.

Develop an estimate of the long-term growth rate that should be used to estimate AirThread’s terminal value. Using your estimate of long-term growth, what is the present value of the AirThread’s going concern value?

If we carefully consider the case, it is evident that the growth rate of the company would be way below the growth rate of Marco Economy in totality. In this case, an assumption is considered to see the growth rate of ATC to be equivalent to 30 years, thus 1981-2011, real GDP growth rate of United States.

Average nominal GDP growth rate= 4.11%.

30-year inflation rate=0.96%. If we use the formulae:

(1+nominal growth rate)= (1+ real growth rate) (1+inflation rate), real growth rate=3.12%.

Therefore, the growth rate of ATC equals 3.12%.

Question 4.

What is the total value of AirThread before considering any synergies? What is the value of AirThread, assuming Ms. Zhang’s estimates for synergies are accurate?

Considering the years 2008-2012, we employ the APV to calculate PV of the cash flow for this duration as shown below.

VL=VU+PV (Int. Tax Shields) = 1295.877+284.783=1580.66 Million

Total PV of Unlevered CF 1295.877
Total PV(ITS) 284.783

For the years after 2012, we use WACC to value the perpetual future cash flow.

According the market multiples in Exhibit 7, D/ (D+E) =28.1%, E/ (D+E) =71.9%.

Finally, we calculate the Total Value of ATC:

VL + Terminal Value=1580.66+8734.33 =10314.99 Million=10.31499 Billion

Tulsa Memorial Hospital (Break-Even Analysis, Case #6, pp. 47-53)

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Tulsa Memorial Hospital (Break-Even Analysis, Case #6, pp. 47-53)

Download the Case 6 excel spreadsheet from here. This spreadsheet contains a model that will assist you in answering the following questions. You should replace the cells in red with the “appropriate” numbers, which may depend on your assumptions.

1. Using the historical data as a guide, construct a pro forma (forecasted) profit and loss statement for the clinic’s average month for all of 2014 assuming the status quo. Explain why you choose the numbers you did. With no change in volume (utilization), is the clinic projected to make a profit?

[HINT: Complete the “Pro Forma Average Month” section of the excel spreadsheet.]

2. Now consider the clinic’s situation without the new marketing program. How many additional daily visits must be generated to break even? Construct a breakeven graph that can be included in your report.

[HINT: Fill out the “Incremental Monthly Costs” portion of the excel spreadsheet. Use the numbers generated by the model to graphically show where the breakeven point is.]

3. Repeat the Question 2 analysis, but now assume that the new marketing program is implemented.

[HINT: If you have finished Q2, the analysis for Q3 and Q4 are already provide by the spreadsheet.]

4. Now focus solely on the expected profitability of the proposed marketing program. How many incremental daily visits must the program generate to make it worthwhile? Construct a breakeven graph. Is the clinic profitable at this point?

5. What is your final recommendation concerning the future of the walk-in-clinic? Consider both the numerical analysis you just conducted and the whether the clinic has any value to the hospital beyond the numerical analysis (i.e. Do the actions by Baptist Hospital have any bearing on the final decision regarding the clinic)?

Audience *

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Audience *

Choose a stakeholder or stakeholder group to receive the explanation of your decision? If you believe the decision should not be made public, then write a memo to the file or to yourself. I picked the stakeholder or you can pick any of your choice.

Subject *

Add a sentence or phrase that clearly identifies the purpose of the communication. A good greeting is engaging and anticipates the conversation.

(Limit of 30 words)

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Background of the Problem *

In your background statement, include sufficient detail so that the recipient knows what the problem is without including any confidential information. Then, clearly present the values in conflict in the problem. A good statement is appropriate for the audience, is polished and coherent, is written from your own voice, and draws the audience into the conversation.

(Limit of 400 words)

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Statement of Decision *

In a sentence, clearly and concisely state your decision. A good statement is understandable, considers the others involved, and connects with your audience.

(Limit of 150 words)

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Reasons for the Decision *

Now, give the reasons for your decision. Use the language of the ethical framework or the ethical principles you used to come to your decision. A good decision statement uses the norms of both ethical lenses, uses logic and emotion to frame the solution, and presents a compelling solution to the problem.

(Limit of 400 words)

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Forward-Looking Conclusion *

The final sentences should build a relationship with the other team members and your constituents, leave the door open for further conversation, and tell the recipient(s) what the decision means for them. A good conclusion is clear, presents a path forward, and is inspiring.

If you have chosen to write a note to yourself, your conclusion should instead focus on your goals for further improvement or the steps you would take to avoid repeating the problem in the future.

(Limit of 200 words)

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Once you’ve completed your memo, we’ll review the implications of your decision.

Theme: Capital Structure and leverage

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Theme: Capital Structure and leverage

Assignment Case 3

Deluxe Corporation

Case 35 page 479

GUIDANCE SHEET

Synopsis

In July 2002, an investment banker advising Deluxe Corporation must prepare recommendations for the company’s board of directors regarding the firm’s financial policy. Some special considerations are the mix of debt and equity, maintenance of financial flexibility, and the preservation of an investment-grade bond rating. Complicating the assessment are low growth and technological obsolescence in the firm’s core business.

The objective is to recommend an appropriate financial policy for Deluxe Corporation and, in support of that recommendation, it is recommended to show the impact on the cost of capital, financial flexibility (i.e., unused debt capacity), bond rating, and other considerations.

Objectives

The following are the analytical objectives of this case study:

· Survey the determinants of corporate bond ratings. The case highlights the important influence of the rating agencies on the costs of debt and the access to capital markets. The case data afford students the opportunity to explore profitability, coverage ratios, and capitalization ratios as measures of credit quality.

· Explore the practical challenges involved in determining the optimal mix of debt and equity, in particular assessing the tradeoff between the benefits of debt tax shields and the costs of financial distress. The case affords the opportunity to highlight methodological problems in estimating the optimal mix.

· Consider the concepts of debt capacity and financial flexibility. The notion advanced in this case is that flexibility is the ability to access capital without falling short of the firm’s minimum target credit rating.

Questions

1. What are the risks associated with Deluxe’s business and strategy? What financing requirements do you foresee for the firm in the coming years?

2. What are the main objectives of the financial policy that Rajat Singh must recommend to Deluxe Corporation’s board of directors?

3. Drawing on the financial ratios in case Exhibit 6, how much debt could Deluxe borrow at each rating level? What capitalization ratios would result from the borrowings implied by each rating category?

4. Is Deluxe’s current debt level appropriate? Why or why not?

5. Using Hudson Bancorp’s estimates of the costs of debt and equity in case Exhibit 8, which rating category has the lowest overall cost of funds? Do you agree with Hudson Bancorp’s view that equity investors are indifferent to the increases in financial risk across the investment-grade debt categories?

6. What should Singh recommend regarding:

· the target bond rating

· the level of flexibility or reserves

· the mix of debt and equity

· any other issues you believe should be brought to the attention of the CEO and the board

P.S. These questions do require calculations but their accuracy is not critical. It will be enough to provide well explained opinions with supporting analysis.

Supporting Spreadsheet Files

To assist student preparation, a MS Excel File is made available to the students which contains several exhibits and a working forecast model. Students however may develop either their own model if they so desire or use the one provided.

MINICASE THE GLOBALIZATION OF WALMART

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MINICASE THE GLOBALIZATION OF WALMART

Founded in Arkansas in 1962, Walmart has developed into the largest retailer in the world. Driven by high levels of service, strong inventory management, and purchasing economies, the company overpowered competitors and became the dominant firm in the U.S. retail industry. After rapid expansion during the 1980s and 1990s, Walmart faced limits to growth in its home market and was forced to look internationally for opportunities. When Walmart opened its first international location in

1991, many skeptics claimed its business practices and culture could not be transferred internationally. Yet, the company’s globalization efforts progressed at a rapid pace. Its more than 6,357 international retail units employ 900,000 associ-ates in 26 international markets. International sales accounted for nearly 30 percent of Walmart’s more than $480 billion in revenues for 2014, a level that is projected to increase sub-stantially over the next decade.

Globalizing Walmart: Where and How to Begin? When Walmart began to expand internationally, it had to decide which countries to target. Although the European retail market was large, Walmart would have had to take mar-ket share from established competitors to succeed there. Instead, Walmart deliberately selected emerging markets as its starting point for international expansion. In the Americas, it targeted nations with large, growing populations—Mexico, Argentina, and Brazil—and in Asia it aimed at China. Lacking the organizational, managerial, and financial resources to simultaneously pursue all of these markets, Walmart focused first on the Americas rather than the more culturally and geo-graphically distant Asian marketplace. For its first international store, opened in 1991 in Mexico

City, Walmart used a 50–50 joint venture to help manage the substantial differences in culture and income between the United States and Mexico. Its partner, the retail conglomer-ate, Cifra, provided expertise in operating in the Mexico mar-ket and a base for learning about retailing in that country. Leveraging its learning from Mexico when it entered Brazil in 1996, Walmart took a majority position in a 60–40 venture with a local retailer, Lojas Americana. When subsequently entering Argentina, Walmart did so on a wholly owned basis. After gaining experience with partners, in 1997 Walmart expanded further in Mexico by acquiring a controlling inter-est in Cifra. By 2014, Walmart’s 2,498 units in Mexico ac-counted for over half of all supermarket sales in Mexico. Still, learning the dos and don’ts was a difficult process. “It

wasn’t such a good idea to stick so closely to the domestic Walmart blueprint in Argentina, or in some of the other inter-national markets,” said the president of Walmart Interna-tional. “We built large parking lots at some of our Mexican stores, only to realize that many of our customers there rode the bus to the store, then trudged across those large parking lots with bags full of merchandise.”a

The Challenge of China The lure of China proved too great to ignore. Walmart was one of the first international retailers in China when it set up opera-tions in 1996. Beijing restricted the operations of foreign retail-ers, including requirements for government-backed partners and limits on the number and location of stores. Walmart subse-quently formed a venture with two politically connected Chinese partners, with Walmart holding a controlling stake. Initial activities were concentrated in Shenzhen, a rapidly grow-ing city bordering Hong Kong, while it learned about Chinese retailing. Walmart had many well-publicized miscues while learning how to do business in China. For example, Walmart no longer tries to sell extension ladders or a year’s supply of soy sauce or shampoo to Chinese customers, who typically live in cramped apartments with limited storage space. Operationally, the scarcity of highly modernized suppliers

in China frustrated Walmart’s initial attempts to achieve high levels of efficiency. Pressured to appease the government’s desire for local sourcing of products, while maintaining the aura of being an American shopping experience, Walmart sourced about 85 percent of the Chinese stores’ purchases from local manufacturers but heavily weighted purchasing toward locally produced American brands (such as products from Procter & Gamble’s factories in China). Walmart also mass-markets Chinese products that were previously avail-able only in isolated parts of the country, such as coconut juice from Guangdong province, hams and mushrooms from rural Yunnan, and oats from Fujian province. Walmart also learned the importance of building relation-ships with agencies from the central and local governments and with local communities. Bureaucratic red tape, graft, and lengthy delays in the approval process proved to be aggravat-ing, but the company learned to curry favor through actions such as inviting Chinese officials to visit Walmart’s American headquarters, assisting local charities, and even building a school for the local community. By 2014, Walmart operated 403 retail units in China and estimated its Chinese operations could be nearly as large as in the United States within 20 years.

India: Anticipating the Opening Up of a Billion-Person Market Although one of the world’s five largest retail markets, at more than $500 billion, and having 400 million people with dispos-able income, the inefficiency of the Indian retail sector is well known. More than 95 percent of retail sales are made through nearly 15 million tea stands, newspaper stalls, and mom-and-pop stores. Strict government barriers have prevented foreign-owned retail businesses, although that situation may be changing. “Many smart people—much smarter than I—believe that India could be the next China,” said John Menzer, the former head of Walmart’s international operations. “So, certainly, as a retailer it’s a place where we’d like to be.”

Exploiting the potential of India could be a major challenge, particularly given the country’s notoriously frustrating bureaucracy and poor infrastructure. Walmart will have to learn to manage highly protectionist and anticapitalist political parties, a bad road system, frequent power outages, difficul-ties acquiring appropriate plots of land, and lack of adequate distribution and cold-storage systems, among other concerns. The diversity of the country could also prove problematic, with 18 official languages, 6,000 castes and subcastes, and widely varying regional consumer cultures. Savvy new Indian chains, such as Provogue and Shoppers’ Stop, are starting to emerge, and nationalistic sentiments may produce much consternation for expansion efforts of foreign companies such as Walmart. To prepare for an eventual opening of the market,

Walmart began establishing relationships with Indian suppliers, distributors, and consumers. In 2007, Walmart established Bharti Walmart, a 50–50 joint venture with Bharti Enterprises, a leader in mobile telecommunications. The venture’s first store opened in 2009. Due to the constraints on retailing, this venture is technically focused on the whole-sale market, selling only to large institutional or wholesale buyers while the company builds up its infrastructure and skills for an eventual liberalization of the retail market. By 2014, the venture had opened 20 Best Price Modern Whole-sale stores, with plans to open additional stores and ultimately be in a market leadership position. Clearly, to succeed when the Indian market finally opens up, Walmart will need to understand the political and market dynamics and exploit the lessons it has learned from entering other emerging markets.

Questions

1. Why has Walmart viewed international expansion as a critical part of its strategy?

2. What did Walmart do to enable the company to achieve success in Latin America and China?

3. What should Walmart do—or not do—to help ensure that the company achieves success in India?

FIN 402 Week 3 Case Problems

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FIN 402 Week 3 Case Problems

Case Problem 6.1 Sara Decides to Take the Plunge

1. LG 1

2. LG 6

Sara Thomas is a child psychologist who has built a thriving practice in her hometown of Boise, Idaho. Over the past several years she has been able to accumulate a substantial sum of money. She has worked long and hard to be successful, but she never imagined anything like this. Even so, success has not spoiled Sara. Still single, she keeps to her old circle of friends. One of her closest friends is Terry Jenkins, who happens to be a stockbroker and who acts as Sara’s financial advisor.

Not long ago Sara attended a seminar on investing in the stock market, and since then she’s been doing some reading about the market. She has concluded that keeping all of her money in low-yielding savings accounts doesn’t make sense. As a result, Sara has decided to move part of her money to stocks. One evening, Sara told Terry about her decision and explained that she had found several stocks that she thought looked “sort of interesting.” She described them as follows:

· North Atlantic Swim Suit Company. This highly speculative stock pays no dividends. Although the earnings of NASS have been a bit erratic, Sara feels that its growth prospects have never been brighter—“what with more people than ever going to the beaches the way they are these days,” she says.

· Town and Country Computer. This is a long-established computer firm that pays a modest dividend yield (of about 1.50%). It is considered a quality growth stock. From one of the stock reports she read, Sara understands that T&C offers excellent long-term growth and capital gains potential.

· Southeastern Public Utility Company. This income stock pays a dividend yield of around 5%. Although it’s a solid company, it has limited growth prospects because of its location.

· International Gold Mines, Inc. This stock has performed quite well in the past, especially when inflation has become a problem. Sara feels that if it can do so well in inflationary times, it will do even better in a strong economy. Unfortunately, the stock has experienced wide price swings in the past. It pays almost no dividends.

Questions

a. What do you think of the idea of Sara keeping “substantial sums” of money in savings accounts? Would common stocks make better investments for her than savings accounts? Explain.

Answer: It is not a smart idea for Sara to retain substantial sums of money in her savings account for the reason that she could potentially make more money by investing in stocks. For example, the average rate for a savings account is 0.06%, and if you invest in stock, you can make anywhere from 0-15% depending on the amount of risk you is willing to take.

b. What is your opinion of the four stocks Sara has described? Do you think they are suitable for her investment needs? Explain.

Answer: Three out of the four stocks are ok investments to make since there is so little information provided. I do not think the NASS is a good investment because the stock pays no dividends and their earnings have been erratic. If Sara wants to make more money for her investments, she needs to find a company that has better growth potential and dividend payouts.

c. What kind of common stock investment program would you recommend for Sara? What investment objectives do you think she should set for herself, and how can common stocks help her achieve her goals?

Answer: The IPA program would be the program I would recommend to Sara because it allows Sara to take classes and speak with educated individuals who know about investing. I think Sara should sit down with a financial advisor and figure out exactly what she wants to do with her money and how much she wants to make from her investments. Common stocks can help her reach her goal faster because they offer a higher return than a savings account.

Case Problem 6.2 Wally Wonders Whether There’s a Place for Dividends

1. LG 5

Year Expected EPS ($) Expected Dividend Payout Ratio (%)
2016 $3.25 40%
2017 $3.40 40%
2018 $3.90 45%
2019 $4.40 45%
2020 $5.00 45%

2. LG 6

Wally Wilson is a commercial artist who makes a good living by doing freelance work—mostly layouts and illustrations—for local ad agencies and major institutional clients (such as large department stores). Wally has been investing in the stock market for some time, buying mostly high-quality growth stocks as a way to achieve long-term growth and capital appreciation. He feels that with the limited time he has to devote to his security holdings, high-quality issues are his best bet. He has become a bit perplexed lately with the market, disturbed that some of his growth stocks aren’t doing even as well as many good-grade income shares. He therefore decides to have a chat with his broker, Al Fried.

During their conversation, it becomes clear that both Al and Wally are thinking along the same lines. Al points out that dividend yields on income shares are indeed way up and that, because of the state of the economy, the outlook for growth stocks is not particularly bright. He suggests that Wally seriously consider putting some of his money into income shares to capture the high dividend yields that are available. After all, as Al says, “the bottom line is not so much where the payoff comes from as how much it amounts to!” They then talk about a high-yield public utility stock, Hydro-Electric Light and Power. Al digs up some forecast information about Hydro-Electric and presents it to Wally for his consideration:

The stock currently trades at $60 per share. Al thinks that within five years it should be trading at $75 to $80 a share. Wally realizes that to buy the Hydro-Electric stock, he will have to sell his holdings of CapCo Industries—a highly regarded growth stock that Wally is disenchanted with because of recent substandard performance.

Questions

a. How would you describe Wally’s present investment program? How do you think it fits him and his investment objectives?

Answer: Wally has a good investment program right because high-quality growth stocks are a good way to make money, but he needs to change the type of stock he is invested in because it is not meeting up to his expectations. His investments are for long-term, which is what he is looking for.

b. Consider the Hydro-Electric stock.

1. Determine the amount of annual dividends Hydro-Electric can be expected to pay over the years 2016 to 2020.

Answer:

Year Expected EPS Payout Ratio Divided
2016 $3.25 40% $1.30
2017 $3.25 40% $1.30
2018 $3.25 45% $1.46
2019 $3.25 45% $1.46
2020 $3.25 45% $1.46

2. Compute the total dollar return that Wally will make from Hydro-Electric if he invests $6,000 in the stock and all the dividend and price expectations are realized.

Answer:

Year Dividends Share Share Shares Value
2016 $1.30 100 $130.00
2017 $1.36 100 $136.00
2018 $1.76 100 $176.00
2019 $1.98 100 $198.00
2020 $2.25 100 $225.00

3. If Wally participates in the company’s dividend reinvestment plan, how many shares of stock will he have by the end of 2020? What will they be worth if the stock trades at $80 on December 31, 2020? Assume that the stock can be purchased through the dividend reinvestment plan at a net price of $50 a share in 2016, $55 in 2017, $60 in 2018, $65 in 2019, and $70 in 2020. Use fractional shares, to 2 decimals, in your computations. Also, assume that, as in part b, Wally starts with 100 shares of stock and all dividend expectations are realized.

Answer:

Year Beginning shares Price Shares Value Dividends Dividends Per Share
2016 100.00 $1.30 $130.00 $50.00 2.60
2017 102.60 $1.36 $139.54 $55.00 2.54
2018 105.14 $1.76 $185.04 $60.00 3.08
2019 108.22 $1.98 $214.28 $65.00 3.30
2020 111.52 $2.25 $250.91 $70.00 3.58
END 2020 $80.00
SHARES END 2020 115.10 SHARE VALUE END 2020 $9,208.17

c. Would Wally be going to a different investment strategy if he decided to buy shares in Hydro-Electric? If the switch is made, how would you describe his new investment program? What do you think of this new approach? Is it likely to lead to more trading on Wally’s behalf? If so, can you reconcile that with the limited amount of time he has to devote to his portfolio?

Answer: Wally will not be changing him the investment strategy if he wants to purchase stock in Hydro-Electric. He would be altering the way he is investing. It is a common practice amongst aggressive investors in a long term goal. If Wally changed back to investing in his long-term shares and invests the way he usually does it. I think this new approach is a good idea and if things work out, I believe it would lead to more trading for him.

Case Problem 7.1 Some Financial Ratios Are Real Eye-Openers

1. LG 5

2. LG 6

Cash $ 1,250
Accounts receivable $ 8,000 Current liabilities $10,000
Inventory $12,000 Long-term debt $ 8,000
Current assets $21,250 Stockholders’ equity $12,000
Fixed and other assets $ 8,750 Total liabilities and
Total assets $30,000 stockholders’ equity $30,000
South Plains Chemical Company Balance Sheet ($ thousands)
Sales $50,000
Cost of goods sold $25,000
Operating expenses $15,000
Operating profit $10,000
Interest expense $ 2,500
Taxes $ 2,500
Net profit $ 5,000
Dividends paid to common stockholders ($ in thousands) $ 1,250
Number of common shares outstanding 5 million
Recent market price of the common stock $ 25
South Plains Chemical Company Income Statement ($ thousands)

Jack Arnold is a resident of Lubbock, Texas, where he is a prosperous rancher and businessman. He has also built up a sizable portfolio of common stock, which, he believes, is due to the fact that he thoroughly evaluates each stock he invests in. As Jack says, “You can’t be too careful about these things! Anytime I plan to invest in a stock, you can bet I’m going to learn as much as I can about the company.” Jack prefers to compute his own ratios even though he could easily obtain analytical reports from his broker at no cost. (In fact, Bob Smith, his broker, has been volunteering such services for years.)

Recently Jack has been keeping an eye on a small chemical stock. The firm, South Plains Chemical Company, is big in the fertilizer business—which is something Jack knows a lot about. Not long ago, he received a copy of the firm’s latest financial statements (summarized here) and decided to take a closer look at the company.

Questions

a. Using the South Plains Chemical Company figures, compute the following ratios.

Latest Industry Averages Latest Industry Averages
Liquidity Profitability
a. Net working capital N/A h. Net profit margin 8.5%
b. Current ratio 1.95 i. Return on assets 22.5%
Activity j. ROE 32.2%
c. Receivables turnover 5.95 Common-Stock Ratios
d. Inventory turnover 4.50 k. Earnings per share $2.00
e. Total asset turnover 2.65 l. Price-to-earnings ratio 20.0
Leverage m. Dividends per share $1.00
f. Debt-equity ratio 0.45 n. Dividend yield 2.5%
g. Times interest earned 6.75 o. Payout ratio 50.0%
p. Book value per share $6.25
q. Price-to-book-value ratio 6.4

b. Compare the company ratios you prepared to the industry figures given in part a. What are the company’s strengths? What are its weaknesses?

Answer: We can see that the SPC Company has a net working capital of $ 11,250,000. It indicates that the SPC Company has $ 11.25 million of working capital available to pay its bill and grow the business. This value is a good sign for SPC Company because it is a higher amount than the industry average. We also can see the current ratio for SPC Company is 2.125 that are more than 0.175 when compare to the industry average, 1.95. It indicates that SPC Company can pay its accounts creditor on time and get the discounts for prompt payment and credibility from future supplies. SPC Company may able to do essential maintenance and replacement of fixed assets, it will result in reducing operating expenses, such that selling expenses and depreciation expenses. Also, the company has a liquid cash for a new investment project, which may increase the future growth rate of the company. This ratio is a good sign for the company. The receivables turnover for SPC Company is 6.25, which is more than 0.3 when you compare it to the industry average of 5.95. It means that the SPC Company is collecting its accounts receivable more quickly than the industry average. The SPC Company can have a valuable discipline on credit control that will possibly result in a bad debt decrease, which is good for SPC Company. The inventory turnover for the SPC Company is 4.167, which is less than 0.333 when you are comparing it to the industry average of 4.5. It might be because the SPC Company may have too many inventories in hand than the industry average. It is expensive because inventories take up costly warehouse space, some inventories may become spoiled or obsolete and also a high risk of stock pilferage. The total asset turnover for SPC Company is 1.67 that is less than 0.98 when you compare it to the industry average of 2.65. It indicates that the company is not able to get any more sales out of its assets than the industry average. The company should reduce the selling price to achieve higher sales volume since they are in a very price competitive industry. When sales volume increase, given no new investment in fixed assets, then the total asset turnover will increase.

As for the compare profitability ratio, we can see that the net profit margin, ROA, and ROE for SPC Company is 10%, 16.67%, 41.67% compared to the industry average of 8.5%, 22.5%, and 32.2% respectively. The results are mixed. When compared to common stock ratios the dividends per share for SPC Company is $ 0.25 that is less than $ 0.75 when compared to the industry average of $ 1.00. Some dividends paid out to the common stockholder is less than the average. Also, the dividend yield for SPC Company is 1 % that is less than 1.5 % when you compare it to the industry average of 2.5 %. It indicates that the rate of current income earned on the investments dollar is less than the average. Moreover, the price-to-book-value for SPC Company is 10.40 that are higher 4.0 when compare to the industry average, 6.4. It indicates that the stock for SPC Company is overpriced than average.

c. What is your overall assessment of South Plains Chemical? Do you think Jack should continue with his evaluation of the stock? Explain

Answer: No, the stock for SPC Company is overpriced. We can see the fact from the price-to-book-value for SPC Company is 10.42 that are higher 4.0 when compare to the industry average, 6.4.

Case Problem 7.2 Doris Looks at an Auto Issue

Doris Wise is a young career woman. She lives in Phoenix, Arizona, where she owns and operates a highly successful modeling agency. Doris manages her modest but rapidly growing investment portfolio, made up mostly of high-grade common stocks. Because she’s young and single and has no pressing family requirements, Doris has invested primarily in stocks that offer the potential for attractive capital gains. Her broker recently recommended an auto company stock and sent her some literature and analytical reports to study. One report, prepared by the brokerage house she deals with, provided an up-to-date look at the economy, an extensive study of the auto industry, and an equally extensive review of several auto companies (including the one her broker recommended). She feels strongly about the merits of security analysis and believes it is important to spend time studying a stock before making an investment decision.

Questions

a. Doris tries to stay informed about the economy on a regular basis. At the present time, most economists agree that the economy is getting stronger. What information about the economy do you think Doris would find helpful in evaluating an auto stock? Prepare a list—and be specific. Which three items of economic information (from your list) do you feel are most important? Explain.

Answer: The majority of economists would agree that a strong economy would affect a company positively. Other factors that Doris should take into consideration before she invests are the following:

1- Jobs and Unemployment – You have to look at the current unemployment rate. People have to be working to qualify for loans to finance or purchase a car.

2- Interest Rates – The interest rate has to be low to entice the consumer to borrow money to purchase a car. When rates are high consumers are less likely to purchase or finance a car.

3- Inflation Rate – Once the price of items starts to go up, many consumers may start to grow concerned about inflation. Once people are concerned about inflation, it starts to affect your investments negatively.

4- Taxes: A tax break can offer savings and incentives through tax credits, deductions and exemptions to order to boost spending.

5- Labor Relations: Labor relations are important because many automakers in the US have to deal with unions and union influence. How they negotiate pay, medical benefits, and retirement benefits has a big impact on how they do business and how they keep their costs in line. But any change in cost from paying higher wages and benefits usually gets passed on to the consumer. Higher prices will mean lower sales.

The most important economic factors I feel is inflation and unemployment. The reason they are the most important is without a job nobody can buy a car and inflation lowers a person buying power which makes them less likely to purchase a car because they may feel the price is too high. It will all impact the car sales.

b. In relation to a study of the auto industry, briefly note the importance of each of the following.

1. Auto imports

Answer: Imported automobiles and those built by foreign manufacturers in the U.S have had a tremendous impact on the domestic industry. Imported automobile have a significant part of the market, and this goes to domestic company end up losing revenue.

2. The United Auto Workers union

Answer: Their unions are known to be aggressive when negotiating for labor benefits.

3. Interest rates

Answer: The average price of a new car now is close to the uppers $30,000, so it’s no surprise that consumers increasingly finance their purchases with loans that last from 5 to 7 years. When interest rates are lower people are willing to borrow more money to purchase big items. When people are paying less interest, it gives them more money to spend and when a consumer has more money to spend that means good news for companies that sell big ticket items like cars and homes.

4. The price of a gallon of gas

Answer: The price of a gallon of gas will reduce the number of cars sales depending on what types of cars the company is selling. Also if the gallon of gas is high, consumers are spending more money to purchase gas than purchasing cars.

c. A variety of financial ratios and measures are provided about one of the auto companies and its stock. These are incomplete, however, so some additional information will have to be computed. Specifically, we know the following:

Net profit margin 15%
Total assets $25 billion
Earnings per share $3.00
Total asset turnover 1.5
Net working capital $3.4 billion
Payout ratio 40%
Current liabilities $5 billion
Price-to-earnings ratio 12.5

Given this information, calculate the following:

1. Sales

Answer:

Total Assets Turnover * Total Assets =

1.5 * $25 Billion= $37.5 Billion

2. Net profits after taxes

Answer:

Net Profit Margin * Sales

15% X $ 37.5 = $5.625 billion

3. Current ratio

Answer:

Current assets = Net working cap + Current liabilities

$3.4 +$5 billion = $ 8.4 Billion

Current assets / Current liabilities = Current ratio

$ 8.4 billion÷ $5 billion= 1.68

4. Market price of the stock

Answer:

Price-to-earnings ratio*Earnings per share

12.5 X $3.00= $37.5 per share

5. Dividend yield

Answer:

(Earnings per share * Payout ratio) ÷ Market price of the stock

($3 X 40%) ÷$37.5= 0.032

0.032 X 100 =3.2%

Case Problem 8.1 Chris Looks for a Way to Invest His Wealth

1. LG 1

2. LG 2

3. LG 4

Chris Norton is a young Hollywood writer who is well on his way to television superstardom. After writing several successful television specials, he was recently named the head writer for one of TV’s top-rated sitcoms. Chris fully realizes that his business is a fickle one, and on the advice of his dad and manager, he has decided to set up an investment program. Chris will earn about a half-million dollars this year. Because of his age, income level, and desire to get as big a bang as possible from his investment dollars, he has decided to invest in speculative, high-growth stocks.

Chris is currently working with a respected Beverly Hills broker and is in the process of building up a diversified portfolio of speculative stocks. The broker recently sent him information on a hot new issue. She advised Chris to study the numbers and, if he likes them, to buy as many as 1,000 shares of the stock. Among other things, corporate sales for the next three years have been forecasted as follows:

Year Sales ($ millions)
1 $22.5
2 $35.0
3 $50.0

The firm has 2.5 million shares of common stock outstanding. They are currently being traded at $70 a share and pay no dividends. The company has a net profit rate of 20%, and its stock has been trading at a P/E of around 40 times earnings. All these operating characteristics are expected to hold in the future.

Questions

a. Looking first at the stock:

1. Compute the company’s net profits and EPS for each of the next 3 years.

Answer:

Year 1

120/100) * 22.5 = $27 million

Therefore 27-22.5= $4.5 million

Profit= 4.5/70

= $64,285.71

Year 2

20% * 35.0 = $7

$7 million/70

Profit= $100,000

Year 3

20% of 50 = $ 10 million

10million/70

Profit = $142857.14285

2. Compute the price of the stock three years from now.

Answer:

Price of stocks= total profits for 3 years + total sales

= (4.5+7+10) + 107.5

= $129 million

3. Assuming that all expectations hold up and that Chris buys the stock at $70, determine his expected return on this investment.

Answer:

$ Stock= $ 70.00

Total sales = $107.5 million

Return = $107,500,000/70

=$535,714.29

Profit= 20% of $535,714.29

= $107,142.85

Total return= $535,714.29+$10,712.85

= $546,427.14

4. What risks is he facing by buying this stock? Be specific.

Answer: The earning per share is not stable, and therefore Chris might run into high percentage loss. The 40% times earning will, therefore, be tempered which will make the investment drop.

5. Should he consider the stock a worthwhile investment candidate? Explain.

Answer: Yes, The EPS from the previous years have constantly been increasing, and therefore this shows a significant increase and the net profit.

b. Looking at Chris’s investment program in general:

1. What do you think of his investment program? What do you see as its strengths and weaknesses?

Answer: Constant change to EPS is the only weakness if not so, therefore, this program is good.

2. Are there any suggestions you would make?

Answer: The suggestion I would make is to determine the appropriate asset allocation. Chris needs to have a strategy whereby the input should remain a hundred percent.

3. Do you think Chris should consider adding foreign stocks to his portfolio? Explain.

Answer: I would say yes because I think it will amplify the expansion of Chris’ investments and therefore increasing the input per EPS.

Case Problem 8.2 An Analysis of a High-Flying Stock

1. LG 2

2. LG 6

Marc Dodier is a recent university graduate and a security analyst with the Kansas City brokerage firm of Lippman, Brickbats, and Shaft. Marc has been following one of the hottest issues on Wall Street, C&I Medical Supplies, a company that has turned in an outstanding performance lately and, even more important, has exhibited excellent growth potential. It has five million shares outstanding and pays a nominal annual dividend of $0.05 per share. Marc has decided to take a closer look at C&I to assess its investment potential. Assume the company’s sales for the past five years have been as follows:

Year Sales ($ millions)
2012 $10.0
2013 $12.5
2014 $16.2
2015 $22.0
2016 $28.5

Marc is concerned with the future prospects of the company, not its past. As a result, he pores over the numbers and generates the following estimates of future performance:

Expected net profit margin 12%
Estimated annual dividends per share 5¢
Number of common shares outstanding No change
P/E ratio at the end of 2017 35
P/E ratio at the end of 2018 50

Questions

a. Determine the average annual rate of growth in sales over the past five years. (Assume sales in 2011 amounted to $7.5 million.)

1. Use this average growth rate to forecast revenues for next year (2017) and the year after that (2018).

Answer:

Year Growth Rate
2012 to 2013 ( 12.5 – 10.0 )/10.0 = 0.250
2013 to 2014 ( 16.2 – 12.5 )/12.5 = 0.296
2014 to 2015 ( 22.0 – 16.2 )/16.2 = 0.358
2015 to 2016 ( 28.5 – 22.0 )/22.0 = 0.296

250 + .296 + .358 + .296 / 4 = .30

Average Annual Growth Rate = 30%

2. Now determine the company’s net earnings and EPS for each of the next two years (2017 and 2018).

Answer:

Earnings in 2017

Sales x Profit margin

$37,000,000 x 0.12

= $4,440,000

Earnings in 2018

Sales x Profit margin

$48,100,000 x 0.12

= $5,772,000

EPS: 2017

$4,440,000 / 5,000,000 = $0.89

= $0.89

EPS: 2018

$5,772,000 / 5,000,000 = $1.15

= $1.15

3. Finally, determine the expected future price of the stock at the end of this two-year period.

Answer:

P/E ratio for 2006 = 50

Share Price, 2006

P/E ratio for 2006 x 2006 EPS

50 x $1.15 = $57.50

$57.50 Share Price

b. Because of several intrinsic and market factors, Marc feels that 25% is a viable figure to use for a desired rate of return.

1. Using the 25% rate of return and the forecasted figures you came up with in question a, compute the stock’s justified price.

Answer:

Price of the share

We can calculate the price of the share by using PE ratio

PE ratio is MPS/EPS i.e market price of share to earnings per share

for 2017= PE ratio is given as 35

35=MPS/0.89376

MPS=31.28

For 2018

50=MPS/1.1676

MPS=58.38

2. If C&I is currently trading at $32.50 per share, should Marc consider the stock a worthwhile investment candidate? Explain.

Answer:

The stock is currently trading for $32.5 per share which is less than the value we have calculated. so Marc should consider it as a worthwhile investment because the MPS is going to pick up more in future.

Case Problem 9.2 Deb Takes Measure of the Market

1. LG 5

Several months ago, Deb Forrester received a substantial sum of money from the estate of her late aunt. Deb initially placed the money in a savings account because she was not sure what to do with it. Since then, however, she has taken a course in investments at the local university. The textbook for the course was, in fact, this one, and the class just completed this chapter. Excited about what she has learned in class, Deb has decided that she definitely wants to invest in stocks. But before she does, she wants to use her newfound knowledge in technical analysis to determine whether now would be a good time to enter the market.

Deb has decided to use all of the following measures to help her determine if now is, indeed, a good time to start putting money into the stock market:

· Advance-decline line

· New highs-new lows indicator (Assume the current 10-day moving average is 0 and the last 10 periods were each 0.)

· Arms index

· Mutual fund cash ratio

Deb goes to the Internet and, after considerable effort, is able to put together the accompanying table of data.

Questions

a. Based on the data presented in the table, calculate a value (where appropriate) for periods 1 through 5, for each of the four measures listed above. Chart your results, where applicable.

Answer:

The Arms index = (The number of advancing stocks/The number of declining stocks)/(The composite volume of advancing stocks/The composite volume of declining stocks)

Arms Index[(Advancing issues(NYSE)/Declining issues (NYSE))/(Volume up/Volume down) 0.525821596 0.20439551 1.91830855 0.696730457 0.39463639

b. Discuss each measure individually and note what it indicates for the market, as it now stands. Taken collectively, what do these four measures indicate about the current state of the market? According to these measures, is this a good time for Deb to consider getting into the market, or should she wait a while? Explain.

Answer:

It is fairly bullish for investment purpose in period 1 period2period 4 and period 5 since Arms index is below 1. Anything above 1as in the case of period 3 is considered bearish. An Arms index of1 is said to be balanced market.

Period 1 Period 2 Period 3 Period 4 Period 5

Mutual Fund Cash

ratio(MututalFund

cash/Total Assets) 4% 5% 7% 9% 10%

c. Comment on the time periods used in the table, which are not defined here. What if they were relatively long intervals of time? What if they were relatively short? Explain how the length of the time periods can affect the measures.

Answer:

Mutual fund cash ratio is below 5% for period 1 which seems fairly bullish. The perspective remains balanced for period 2.However since Mutual fund cash ratio is above 5% for period 3period 4 Period 5, the sentiment is fairly bearish and not advisable for making investments under these periods.

A/D Line = (No of Advancing Stocks – No of Declining Stocks) + Previous Period’s A/D Line Value

Period 1 Period 2 Period 3 Period 4 Period 5

AD Line

(Advancing

Issues

(NYSE)-

Declining issues

(NYSE) -1,010 -1,704 -2,414 -1,832 -1,224

As per AD Line, The Sentiment is fairly bearish with regard to all periods and hence investment should be avoided.

Period 1 Period 2 Period 3 Period 4 Period 5
Dow Jones Industrial Average 8,300 7,250 8,000 9,000 9,400
Dow Transportation Average 2,375 2,000 2,000 2,850 3,250
New highs $  68 $  85 $  85 $ 120 $ 200
New lows $  75 $  60 $  80 $  75 $  20
Volume up 600,000,000 836,254,123 275,637,497 875,365,980 1,159,534,297
Volume down 600,000,000 263,745,877 824,362,503 424,634,020 313,365,599
Mutual fund cash (trillions of dollars) $0.31 $0.32 $0.47 $0.61 $0.74
Total assets managed (trillions of dollars) $6.94 $6.40 $6.78 $6.73 $7.42
Advancing issues (NYSE) 1,120 1,278 1,270 1,916 1,929
Declining issues (NYSE) 2,130 1,972 1,980 1,334 1,321