(Statistician Economist)

Module 5 Questions:

1) Here are four industries and four forecasts for the macro-economy. Choose the industry that you would expect to perform best in each scenario.

Industries: Housing construction, health care, gold mining, steel production.

Economic Forecast:

Deep recession: Falling inflation, falling interest rates, falling GDP.

Superheated economy: Rapidly rising GDP, increasing inflation and interest rates.

Healthy expansion: Rising GDP, mild inflation, low unemployment.

Stagflation: Falling GDP, high inflation.

2) You have $5,000 to invest for the next year and are considering three alternatives:

a) A money market fund with an average maturity of 30 days offering a current annualized yield of 3%.

b) A one-year savings deposit at a bank offering an interest rate of 4.5%.

c) A 20-year US Treasury bond offering a yield to maturity of 6% per year.

What role does your forecast of future interest rates play in your decisions?

3) OceanGate sells external hard drives for $200 each. Its total fixed cost are $30 million and its variable costs per unit are $140. The corporate tax rate is 30%. If the economy is strong, the firm will sell 2 million drives, but if there is a recession it will sell only half as many. What is the firm’s degree of operating leverage? If the economy enters a recession, what will be the firms after- tax profit?

4) Eagle Products’ EBIT is $300, its tax rate is 35%, depreciation is $20, capital expenditures are $60, and the planned increase in net working capital is $30. What is the free cash flow to the firm?

5) FinCorps’ free cash flow to the firm is reported as $205 million. The firm’s interest expense is $22 million. Assume the tax rate is 35% and the net debt of the firm increases by $3 million. What is the market value of the equity if the FCFE is projected to grow at 3% indefinitely and the cost of equity is 12%?

6) Even Better Products has come out with a new and improved product. As a result, the firm projects an ROE of 20%, and it will maintain a plowback ratio of .30. Its earnings this year will be $2 per share. Investors expect a 12% rate of return on the stock.

a) At what price and P/E ratio would you expect the firm to sell?

b) What is the present value of growth opportunities?

c) What would be the P/E ratio and the present value of growth opportunities if the firm planned to reinvest only 20% of its earnings?

7) The FI Corporation’s dividends per share are expected to grow indefinitely by 5% per year.

a) If this year’s year-end dividend is $8 and the market capitalization rate is 10% per year, what must the current stock price be according to the DDM?

b) If the expected earnings per share are $12, what is the implied value of the ROE on future investment opportunities?

c) How much is the market paying per share for growth opportunities (that is, for an ROE on future investments that exceeds the market capitalization rate)?

8) Under the following financial statement of Heifer Sports Inc in table 14.14 to find Heifer’s: (SEE ATTACHED TABLE)

a) Inventory Turnover ratio in 2009

b) Debt equity ratio in 2009

c) Cash flow from operating activity in 2009

d) Average collection period

e) Operating profit margin

f) Return on Equity

g) P/E ratio

h) Compound leverage ratio

i) Net cash provided by operating activities

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9) Use the DuPont system and the following data to find the return on equity.

*Leverage ratio 2.2

*Total asset turnover 2.0

*Net profit margin 5.5%

*Dividend payout ratio 31.8%

What is the company’s return on equity?

10) Scott Kelly is reviewing MasterToy’s financial statements in order to estimate its sustainable growth rate. Using the information presented in table 14.19 (SEE ATTACHED TABLE)

a) Identify and calculate the components of the DuPont formula

b) Calculate the ROE for 2009 using the components of the DuPont formula

c) Calculate the sustainable growth rate for 2009 from the firm’s ROE and plowback ratios

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