Posted: July 24th, 2022

# WK 7 HW FIN 550

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Homework Chapter 14 week 7

PROBLEM 6:  Lauren Entertainment, Inc., 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 Entertainment, Inc., assuming its beta is 1.0 and you feel t can maintain its superior growth rate for:

a.        The next 10 years

b.      The next 5 years

PROBLEM 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                                                  30.00                                  27.00                                      18.00

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.

c.       Given these growth durations, what determines your investment decision?

Problem 8:  The value of an asset is the present value of the expected returns from the asset during the holding period.  An investment will provide a stream of returns during this period, and it is necessary to discount this stream of returns at an appropriate rate to determine the set’s present value.  A dividend valuation model such as the following is frequently used.      Pi= D1

—————–

(k i- gi)

Where

Pi = the current price of Common Stock i

D1 = the expected dividend in period 1

Ki = the required rate of return on Stock i

Gi = the expected constant-growth rate of dividends for Stock i

a.        Identify the three factors that must be estimated for any valuation model, and explain why these estimates are more difficult to derive for common stocks than for bonds.

b.      Explain the principal problem involved in using a dividend valuation model to value,

(1)     Companies whose operations are closely correlated with economic cycles.

(2)      Companies that are of very large and mature.

(3)      Companies that are quite small and are growing rapidly.

Assume that all companies pay dividend.

PROBLEM 10:  The constant growth dividend discount model can be used both for the valuation of companies and for the estimation of the long-term term total return of a stock.

Assume               \$ 20=Price of a Stock Today

8%= Expected Growth Rate of Dividend

0.60=Annual Dividend One Year Forward

a. Using only the preceding data, compute the expected long-term total return on the stock using the constant-growth dividend discount model.

c. Identify three alternative methods to the dividend discount model for the valuation of companies.

PROBLEM 11:  An analyst expects a risk-free return of 4.5 percent, a market of 14.5 percent, and the return for Stocks A and B that are show in Exhibit 14.24.

EXHIBIT 14.24 STOCK INFORMATION

STOCK                             BETA                                 Analyst’s Estimated Return

A                                    1.2                                                         16%

B                                     0.8                                                         14%

a.       Show on a graph:

(1)    Where Stocks A and B would plot on the security market line (SML) if they were fairly value using the capital asset pricing model (CAMP).

(2)    Where Stocks A and B actually plot on the same graph according to the return estimated by the analyst and shown in Exhibit 14.24.

b.      State whether Stock A and B are undervalued if the analyst uses the SML for strategic investment decisions

PROBLEM 12:  Lauren Turk is reviewing Francesca Toy’s financial statements in order to estimate its sustainable growth rate.  Using the information presented in Exhibit 14.25.

a.       (1)  Identify and calculate the three components of the DuPont formula.

(2)  Calculate the ROE for 2011, using the three components of the DuPont formula.

(3)  Calculate the sustainable-growth rate for 2011Thank you very much for responding to the topics in such great details.  This is the same type of analysis that I expect from a case study.  Here, you have examined the information presented in the videos and have crafted responses based on the videos.  And, you only included an outside source to support one of your points.  If you complete the assignments in a similar manner, you will do well.  I’m pointing this out so that others can use your responses as examples of how to respond to case study questions.  I want to touch on the drawbacks of horizontal integration that you mentioned.  One of the factors that determine the success of horizontal integration is the level of strategic planning capabilities that the senior managers possess.  In fact, superior strategic planning capabilities has to be one of the core competencies of the leading organization.  If you look at the merger (now 3 years later), there are several things that SWA has done correctly.  First, they acquired Airtran as a wholly owned subsidiary of SWA.  As such, SWA owns 100% of the shares of Airtran.  However, Airtran continued to operate as an independent entity.  So, this minimizes the risks involved with synergies and the pitfalls with integration, such as the clash of cultures.  Airtran continued to target the budget conscious business travelers while SWA continued to target cost conscious consumers.  Though I haven’t done any research on this, I imagine that the salary structures in place for both airlines would continue.  And, as the analyst reported in the video, SWA’s employees are paid very well, even though SWA is a low cost carrier.  The two companies are scheduled to merge fully as one company by the end of 2014.  After that time, we’ll see what the impact will be.  Will the business customers that flew with Airtran now want to fly with SWA?  What do you think?  Clara, for the last section, on corporate level strategy, you have to state a corporate level strategy that is covered in Chapter 9.  I’ll let you tell me, but what type of strategy did you actually propose in the last sentence especially?

b. Turk has calculated actual and sustainable growth for each of the past four years and finds in each year that its calculated sustainable-growth rate substantially exceeds its actual growth rate.  Cite two course of action (other than ignoring the problem) that Turk should encourage Francesca Toy to take, assuming the calculated sustainable-growth rate continue to exceed the actual rate.

Exhibit 14.25 Francesca Toy, Inc:  Actual 2010 and Estimated 2011 Financial Statements for Fiscal Year Ending December 31 (\$ Millions, except Per-Share Data)

2010                             2011e                       Change (%)

Income statement

Revenue                                                          \$ 4,750                         \$ 5,140                             7.5

Coast of goods sold                                       \$ 2,400                         \$ 2,540

Selling general, and administrative               1,400                            1,550

Depreciation                                                          180                               210

Goodwill amortization                                           10                                  10

——————————————————————-

Operating income                                        \$   760                                     \$ 830                                     8.4

Interest expense                                                 20                                          25

Income before taxes                                   \$   740                                    \$   805

Income taxes                                                     265                                           295

Net income                                                  \$   475                                    \$     510

Earnings per share                                     S   1.79                                    \$     1.96                                  8.6

Average shares outstanding (mil)                265                                             260

BALANCE SHEET

Cash                                                              \$   400                                    \$      400

Accounts receivable                                  \$   680                                    \$      700

Inventories                                                 \$   570                                     \$      600

Net property, and equipment                \$    800                                     \$      870

Intangibles                                                 \$    500                                     \$       530

Total assets                                               \$   2,950                                   \$    3,100

Current liabilities                                     \$      550                                   \$         600

Long-term debt                                        \$      300                                   \$         300

Total liabilities                                          \$     850                                    \$         900

Stockholders’ equity                               \$   2,100                                    \$    2,200

Total liabilities and equity                     \$   2,950                                    \$   3,100

Book value per share                              \$     7.92                                   \$      8.46

Annual dividend per share                    \$     0.55                                   \$      0.60

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