FINANCE Investment Analysis and Portfolio Management CHAPTER 12 TO 18 QUESTIONS AND PROBLEMS
CHAPTER 12 QUESTIONS
1 Why would you expect a relationship between economic activity and stock price movements
2. At a lunch with some business associates, you discuss the reason for the relationship between the economy and the stock market. One of your associates contends that she has heard that stock prices typically turn before the economy does. How would you explain this phenomenon?
3. Explain the following statements ： (a)There is a strong, consistent relationship between money supply changes and stock prices. (b)Money supply changes cannot be used to predict stock price movements.
4. You are informed of the following estimates ： Nominal money supply is expected to grow at a rate of 7 percent, and GDP is estimated to grow at 4 percent. Explain what you think will happen to stock prices during this period and the reason for your expectation.
5. The current rate of inflation is 3 percent, and long-term Treasury bonds are yielding 7 percent. You estimate that the rate of inflation will increase to 6 percent. What do you expect to happen to long-term bond yields? Compute the effect of this change in inflation on the price of a 15-year, 10 percent coupon bond with a current yield to maturity of 8 percent.
6. Some observers contend that it is harder to estimate the effect of a change in interest rates on common stocks than on bonds. Discuss this contention.
7. An investor is convinced that the stock market will experience a substantial increase next year because corporate earnings are expected to rise by at least 12 percent. Do you agree or disagree? Why or why not?
9. To arrive at an estimate of the net profit margin, why would you spend time estimating the operating profit margin and work down?
10. You are convinced that capacity utilization next year will decline from 82 percent to about 79 percent. Explain what effect this change will have on the operating profit margin.
11. You see an estimate that hourly wage rates will increase by 6 percent next year. How does this affect your estimate of the operating profit margin? What other information do you need to determine the effect of this wage rate increase and why do you need it?
12. It is estimated that, next year, hourly wage rates will increase by 7 percent and productivity will increase by 5 percent. What would you expect to happen to unit labor cost? Discuss how this unit labor cost estimate would influence your estimate of the operating profit margin.
13. Assume that each of the following changes id independent (i.e., except for this change, all other factors remain unchanged).In each case, indicate what will happen to the earnings multiplier and explain why a. The return on equity increases b. The aggregate debt-equity ratio declines c. Overall productivity of capital increases d. The dividend-payout ratio declines
CHAPTER 12 PROBLEMS
4. You are told that nominal GDP will increase by about 10 percent next year. Using Exhibit 12.15 and the regression equation, what increase would you expect in corporate sales? How would this estimate change if you gave more weight to the recent observations?
5. Currently, the dividend-payout ratio(D/E) for the aggregate market is 60 percent, the required return (k) is 11 percent ， and the expected growth rate for dividends(g)is 5 percent.
a. Compute the current earnings multiplier.
b. You expect the D/E ratio to decline to 50 percent, but you assume there will be no other changes. What will be the P/E?
c. Starting with the initial conditions. You expect the dividend-payout ratio to be constant ， the rate of inflation to increase by 3 percent, and the growth rate to increase by 2 percent. Compute the expected P/E.
d. Starting with the initial conditions, you expect the dividend-payout ratio to be constant, the rate of inflation to decline by 3 percent, and the growth rate to decline by 1 percent. Compute the expected P/E.
6. As an analyst for Charlotte, Chelle, and Denise, you are forecasting the market P/E ratio using the dividend discount model. Because the economy has been expanding for 9 years, you expect the dividend-payout ratio will be at its low of 40 percent and that long-term government bond rates will rise to 7 percent. Because investors are becoming less risk averse, the equity risk premium will decline to 3 percent. As a result, investors will require a 10 percent return, and the return on equity will be 12 percent. a. What is the expected growth rate? b. What is your expectation of the market P/E ratio? c. What will be the value for the market index if the expectation is for earnings per share of $63.00?
7. You are given the following estimated per share data related to the S&P Industrials Index for the year 2007:
Sales: $1,020.00
Depreciation: 45.00
Interest expense: 18.00
You are also informed that the estimated operating profit margin is 0.152 and the tax rate is 32 percent.
a. Compute the estimated EPS for 2007.
b. Assume that a member of the research committee for your firm feels that it is important to consider a range of operating profit margin (OPM) estimates. Therefore, you are asked to derive both optimistic and pessimistic EPS estimates using 0.149 and 0.155 for the OPM and and holding everything else constant.
8. Given the three EPS estimates in Problem 7.you are also given the following estimates related to the market earnings multiple:
Pessimistic; Consensus; Optimistic
D/E---0.65; 0.55; 0.45
Nominal RFR---0.10; 0.09; 0.08
Risk premium---0.05; 0.04; 0.03
ROE----0.10; 0.13; 0.16
a. Based on the three EPS and P/E estimates, compute the high, low, and consensus intrinsic market value for the S&P Industrials Index in 2007 ．
b. Assuming that the S&P Industrials Index at the beginning of the year was priced at 1,600, compute your estimated rate of return under the three scenarios from Part a. Assuming your required rate of return is equal to the consensus, how would you weight the S&P Industrials Index in your global portfolio?
9. You are analyzing the U.S. equity market based upon the S&P Industrials Index and using the present value of free cash flow to equity technique. Your inputs are as follows ： Beginning FCFE ： $40.00 k=0.09 Growth Rate: Year 1-3: 9 ％
4-6: 8 ï¼…
7 and beyond: 7 ï¼…
a. Assuming that the current value for the S&P Industrials Index is 1600, would you underweight, overweight, or market weight the U.S. equity market? b. Assume that there is a 1 percent increase in the rate of inflation--what would be the market's value and how would you weight the U.S. market? State your assumptions.
Chapter 13
QUESTIONS
1. Briefly describe the results of studies that examined the performance of alternative industries during specific time periods and discuss their implications for industry analysis.
2. Briefly describe the results of the studies that examined industry performance over time. Do these results complicate or simplify industry a analysis?
3. Assume all the firms in a particular industry have consistently experienced similar rates of return. Discuss what this implies regarding the importance of industry and company analysis for this industry.
4. Discuss the contention that differences in the performance of various films within an industry limit the usefulness of industry analysis.
5. Several studies have examined the difference in risk for alternative industries during a specified time period. Describe the results of these studies and discuss their implications for industry analysis.
6. What were the results when industry risk was examined during successive time periods? Discuss the implication of these results for industry analysis.
7. Assume the industry you are analyzing is in the fourth stage of the industrial life cycle. How would you react if your industry-economic analysis predicted that sales per share for this industry would increase by 20 percent? Discuss your reasoning.
8. Discuss at what stage in the industrial life cycle you would like to discover an industry. Justify your decision.
9. Give an example of an industry in Stage 2 of the industrial life cycle. Discuss your reasoning for putting the industry in Stage 2 and any evidence that caused you to select this stage for the industry.
10. Discuss an example of input-output analysis to predict the sales for the auto industry. Discuss how you would use input-output analysis to predict the costs of production for the auto industry.
11. Discuss the impact of the threat of substitute products on the steel industry's profitability
12. Discuss the two variables that must be considered whether you are using the present value of cash flow approach or the relative valuation ratio approach to valuation. Why are these variables relevant for either valuation approach?
13. List the three variables that are relevant when attempting to determine whether the earnings multiple (P/E ratio) for an industry should be higher, equal to, or lower than the market multiple.
14. Discuss when you would use the two-stage growth FCFE model rather than the constant growth model.
15. You are examining the P/EF ratio for an industry compared to the market and find that the industry ratio has always been at a discount to the market--for example, the industry-market ratio of ratios is about 0.80.Discuss the variable(s) you would examine to explain this difference or to justify an increase in the industry-market ratio.
CHAPTER 13 PROBLEMS
9 You know the following about your industry(I) and the market(M) ： ROE I : 12 ％ RR I ： 0.60 Beta I : 1.05 ROE M ： 16 ％ RR M : 0.55 Beta M : 1.00 Discuss what difference you would expect in the P/Es, and explain why you expect this difference.
Chapter 14
QUESTIONS
1. Give an example of a growth company and discuss why you identify it as such. Based on its P/E, do you think it is a growth stock? Explain.
2. Give an example of a cyclical stock and discuss why you have designated it as such. Is it issued by a cyclical company?
3. A biotechnology firm is growing at a compound rate of over 21 percent a year.(Its ROE is over 30 percent, and it retains about 70 percent of its earnings.)The stock of this company is priced at about 65 times next year's earnings. Discuss whether you consider this a growth company and/or a growth stock.
8. Under what conditions would you use a two-or three-stage cash flow model rather than the constant-growth model?
9. What is the rationale for using the price/book value ratio as a measure of relative value?
10. What would you look for to justify a price/book value ratio of 3.0? What would you expect to be the characteristics of a firm with a P/BV ratio of 0.6?
11. Why has the price/cash flow ratio become a popular measure of relative value during the recent past? What factors would help explain a difference in this ratio for two firms?
12. Assume that you uncover two stocks with substantially different price/sales ratios (e.g.,0.5 versus 2.5). Discuss the factors that might explain the difference.
13. Specify the major components for the calculation of economic value added and describe what a positive EV A signifies.
14. Discuss why you would want to use EV A return on capital rather than absolute EV A to compare two companies or to evaluate a firm's performance over time.
15. Differentiate between EV A and MV A and discuss the relatively weak relationship between these two measures of performance. Is this relationship surprising to you? Explain.
16. Discuss the two factors that determine the franchise value of a firm. Assuming a firm has a base cost of equity of 1l percent and does not have a franchise value, what will be its P/E?
17. You are told that a company retains 80 percent of its earnings, and its earnings are growing at a rate of about 8 percent a year versus an average growth rate of 6 percent for all firms. Discuss whether you would consider this a growth company.
18. It is contended by some that in a completely competitive economy, there would never be a true growth company. Discuss the reasoning behind this contention.
19. Why is it not feasible to use the dividend discount model in the valuation of true growth companies?
20. Discuss the major assumptions of the growth duration model. Why could these assumptions present a problem?
21. You are told that a growth company has a P/E ratio of 13 times and a growth rate of 15 percent compared to the aggregate market, which has a growth rate of 8 percent and a P/E ratio of 16 times. What does this comparison imply regarding the growth company? What else do you need to know to properly compare the growth company to the aggregate market?
22. Given the alternative companies described in the chapter (negative growth, simple growth, dynamic growth), indicate what your label would be for Walgreens. Justify your label.
23. Indicate and justify a growth label for General Motors.
CHAPTER 13 PROBLEMS
3. Given Hitech's beta of 1.75 and a risk free rate of 7 percent, what is the expected rate of return, assuming
6. Lauren Industries has an 18 percent annual growth rate compared to the market rate of 8 percent. If the market multiple is 18,determine P/E ratios for Lauren Industries, assuming its beta is 1.0 and you feel it can maintain its superior growth rate for
a. the next 10 years
b. the next 5 years
7. You are given the following information about two computer software firms and the S&P Industrials Company A; Company B; S&P Industrials
P/E ratio----30.0; 27.0; 18.0
Expected annual growth rate----0.18; 0.15; 0.07
Dividend yield----0.00; 0.01; 0.02
a. Compute the growth duration of each company stock relative to the S&P Industrials.
b. Compute the growth duration of Company A relative to Company B.
c. Given these growth durations, what determines your investment decision?
Chapter 17
QUESTIONS
1. Explain the difference between calling a bond and a bond refunding.
2. Identify the three most important determinant of the price of a bond. Describe the effect of each.
3. Given a change in the level of interest rates, discuss how two major factors will influence the relative change in price for individual bonds.
4. Briefly describe two indenture provisions that can affect the maturity of a bond.
5. Explain the differences in taxation of income from municipal bonds, from U.S. Treasury bonds, and from corporate bonds.
6. For several institutional participants in the bond market, explain what type of bond each is likely to purchase and why.
7. Why should investors be aware of the trading volume for bonds in their portfolio?
8. What is the purpose of bond ratings?
9. Based on the data in Exhibit 17.1, which is the fastest-growing bond market in the world? Which markets are losing market share?
10. Based on the data in Exhibit 17.2, discuss the makeup of the Japanese bond market and how and why it differs from the U.S. market.
11. Discuss the positives and negatives of investing in a government agency issue rather than a straight Treasury bond.
12. Discuss the difference between a foreign bond (e.g., a Samurai) and a Eurobond(e.g., a Euroyen issue).
CHAPTER 17 PROBLEMS
1. An investor in the 28 percent tax bracket is trying to decide which of two bonds to purchase. One is a corporate bond carrying an 8 percent coupon and selling at par. The other is a municipal bond with a 5.5 percent coupon, and it, too, sells at par. Assuming all other relevant factors are equal, which bond should the investor select?
2. What would be the initial offering price for the following bonds (assume semiannual compounding) ：
a. A 15-year zero coupon bond with a yield to maturity (YTM) of 12 percent.
b. A 20-year zero coupon bond with a YTM of 10 percent.
3. An 8.4 percent coupon bond issued by the state of Indiana sells for $1.000. What coupon rate on a corporate bond selling at its $1,000 par value would produce the same after-tax return to the investor as the municipal bond if the investor is in
a. the 15 percent marginal tax bracket?
b. the 25 percent marginal tax bracket?
c. the 35 percent marginal tax bracket? ETY=i/(1-t)
4. The Shamrock Corporation has just issued a $1,000 par value zero coupon bond with an 8 percent yield to maturity, due to mature 15 years from today (assume semiannual compounding)
a. What is the market price of the bond?
b. If interest rates remain constant, what will be the price ot the bond in three years?
c. If interest rates rise to 10 percent, what will be the price of the bond in three years?
5 Complete the information requested for each of the following $1,000 face value, zero coupon bonds, assuming semiannual compounding.
Bond Maturity(Years) Yield(Percent)Price($)
A 20 12 ?
B ? 8 601
C 9 ? 350
Chapter 18
QUESTIONS
1. Why does the present value equation appear to be more useful for the bond investor than for the common stock investor?
2. What are the important assumptions made when you calculate the promised yield to maturity? What are the assumptions when calculating promised YTC?
3. a. Define the variables included in the following model ：
i =(RFR,I,RP)
b. Assume that the firm whose bonds you are considering is not expected to bleak even this year. Discuss which factor will be affected by this information.
4. We discussed three alternative hypotheses to explain the term structure of interest rates. Briefly discuss the three hypotheses and indicate which one you think best explains the alternative shapes of a yield curve.
7. You expect interest rates to decline over the next six months
a. Given your interest rate outlook, state what kinds of bonds you want in your portfolio in terms of duration and explain your reasoning for this choice.
b. Y ou must make a choice between the following three sets of noncallable bonds. For each set select the bond that would be best for your portfolio given your interest rate outlook and the consequent strategy set forth in Part a. In each case briefly discuss why you selected the bond.
Bonds; Maturity; Coupon; Yield to Maturity
Set 1 ： Bond A 15 years 10% 10%
Bond B 15 years 6% 8%
Set 2 ： Bond C 15 years 6% 10%
Bond D 10 years 8% 10%
Set 3 ： Bond E 12 years 12% 12%
Bond F 15 years 12% 8%
8. At the present time, you expect a decline in interest rates and must choose between two portfolios of bonds with the following characteristics ：
Portfolio A Portfolio B
Average maturity 10.5 years 10.0 years
Average YTM 7% 10%
Modified duration 5.7 years 4.9 years
Modified convexity 125.18 40.30
Call features Noncallable Deferred call features that range from 1 to 3 years Select one of the portfolios and discuss three factors that would justify your selection.
9. The Chartered Finance Corporation has issued a bond with the following characteristics ： Maturity--25 years
Coupon--9%
Yield to maturity--9%
Callable--after 3 years@109
Duration to maturity--8.2 years
Duration to first call--2.1 years
a. Discuss the concept of call-adjusted duration and indicate the approximate value (range) for it at the present time.
b. Assuming interest rates increase substantially (i.e., to 13 percent), discuss what will happen to the call-adjusted duration and the reason for the change.
c. Assuming interest rates decline substantially (i.e., they decline to 4 percent),discuss what will happen to the bond's call-adjusted duration and the reason for the change.
d. Discuss the concept of negative convexity as it relates to this bond.
CHAPTER 18 PROBLEMS
1. Four years ago ， your firm issued $1,000 par, 25-year bonds, with a 7 percent coupon rate and a 10 percent call premium.
a. lf these bonds are now called, what is the approximate yield to call for the investors who originally purchased them?
b. If these bonds are now called, what is the actual yield to call for the investors who originally purchased them at par?
c If the current interest rate is 5 percent and the bonds were not callable, at what price would each bond sell?
2. Assume that you purchased an 8 percent, 20-year,$1,000 par, semiannual payment bond priced at $l,012.50 when it has 12 years remaining until maturity. Compute ：
a. Its promised yield to maturity
b. Its yield to call if the bond is callable in three years with an 8 percent premium.
3. Calculate the duration of an 8 percent, $1,000 par bond that matures in three years if the bond's YTM is 10 percent and interest is paid semiannually.
a. Calculate this bond's modified duration.
b. Assuming the bond's YTM goes from 10 percent to 9.5 percent calculate an estimate of the price change.
4. Two years ago, you acquired a 10-year zero coupon,$ 1,000 par value bond at a 12 percent YTM Recently you sold this bond at an 8 percent YTM. Using semiannual compounding, compute the annualized horizon return for this investment.
5. A bond for the Chelle Corporation has the following characteristics ：
Maturity--12 years
Coupon--10%
Yield to maturity--9.50%
Macaulay duration--5.7 years
Convexity--48
Noncallable
a. Calculate the approximate price change for this bond using only its duration assuming its yield to maturity increased by 150 basis points. Discuss the impact of the calculation including the convexity effect.
b. Calculate the approximate price change for this bond (using only its duration) if its yield to maturity declined by 300 basis points. Discuss (without calculations) what would happen to your estimate of the price change if this was a callable bond.
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