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Point Loma Nazarene University * FIN 415 Finance Mar 8, 2023 12
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You have decided to buy 200 shares of stock selling at 75 dollars per share using margin with an initial margin requirement of 50 percent. The stock pays
an annual dividend of $1.50 per share, paid quarterly . The interest rate on the margin loan is 6 percent. Determine your return on invested capital if the
stock increases to $85 per share in 6 months and you sell it. What is the annual return on this transaction.

# of Shares Price/Sh Total

Market Value of Securities at purchase 200 $ 75.00 $ 15,000.00 a
Market Value of Securities at sale 200 $ 85.00 $ 17,000.00 b
Gain/loss $ 2,000.00 b-a

Dividend received (6 mos.) 200 $ 0.75 $ 150.00 c

Total gain on investment $ 2,150.00 (b-a) + c

purchase Margin Req. % Total

Equity invested $ 15,000 50% $ 7,500
Margin Loan (Mkt Val. At Purchase - Equity invested) $ 7,500
Interest paid on loan @ 6% for 6 mos. $225.00

Return on Invested Capital

Return $ 1,925.00 (Sale value - Purchase Value + Dividend - Interest)

Equity Invested $ 7,500

Return % (6 mos.) 25.67% (Return/Equity Invested)

1 You want to invest in Ocean Surf Inc. common stock, but you think the valuation is a little rich at
its current price of $50. You decide to place a limit order, set to expire in 60 days, to buy 200
shares at $45.00. Discuss what most likely happens in each of the following scenarios (i.e., did
you buy the stock or not, and if bought, at what price?).
a.) The stock drops to $46.50 the next week.
b.) The stock trades in an orderly manner between $42.50 and $55.00 during the 60 day period.
c.) The stock closes the day you placed the order at $50, but opens the next day, following a bad
earnings report after the market closed, at $39.50 and trades at that price most of the morning.
d.) The stock trades in an orderly manner between $45.50 and $55.00 during the 60 day period
and closes the period at $54.25.

The order will not be executed. The limit order will be executed only is the stock prices
falls to $45 or below. However, since there are two or more months before the limit order
expires, it is still conceivable that the stock price might fall to $45
b. If stock price moved smoothly, you likely bought 200 shares @ $45

C. as the stock price moved below limit price, you likely bought 200 shares @ $39.50

d. Since the stock did not reach limit price of $45 then the limit order was not executed

2 You now own 200 shares of Ocean Surf Inc. and it is trading at $53.00 per share. You paid $45 per share and
want to protect some of your gains in case the stock falls. You decide to place a stop loss order at $48 for 100
shares and a stop-limit at $48 for the other 100 shares. After another bad earnings report, the stock drops
immediately to $44, then slowly recovers to $47 during the trading day. What is the likely outcome of this
transaction at the end of the day, with any gain/loss estimate based on the $45/share purchase price? Did
your profit protection plan work to your satisfaction so far?

the likely loss that you would experience is $1 per share ($45-$44 sale), or $100, on the 100 shares with the stop loss order (which converted to a ma
You will still own the other 100 shares with the stop-limit order as the stock has not recovered to the limit price yet. It did not go to plan!

You sell 200 shares short for $50 per share. You want to limit your losses to no
3 more than $1000. The stock is fairly liquid and easy to trade.
a.) What order should you place?
b.) Are you assured that this will work effectively to limit your loss?
c.) If the answer to b.) is no, how could you be more likely to limit your loss to less
than $1000?

a.)
Shares sold short 200.00
sales price (per share) $ 50
proceeds 10000

maximum loss limit $1,000.00

shares sold short 200.00
loss per share $5.00
Order Required: Buy Stop Order at $ 55.00

b.) No; stop loss could be excercised above $55 if market

price moves fast; stop limit wouldn't work because it
could increase losses
c.) lower buy stop price or place a market order before
stock reaches $55

arket order as soons as the stock trades at or below the limit price).

Assume the expected risk-free rate of return on treasury notes is 2.5%, the
expected inflation rate is 2%, and the equity risk premiums on Normal Co.
and Risky Co are 4% and 7.5%, respectively.
a.) Calculate the "real" risk-free rate of return.
b.) Calculate the required market rate of return Normal Co. and Risky Co.

(a) (b)
Investment Risk-Free Inflation Real Risk Prem. Req Return*
Normal Co. 2.5% 2.0% 0.5% 7.5% 10.0%
Risky Co. 2.5% 2.0% 0.5% 4.0% 6.5%

* this is the nominal required rate of return, not the real (inflation-adjusted) rate of return

Assume the risk-free rate of return is currently 3% and the equity market
rate of return is 10%. Given the betas of the Investments noted below:
a.) what is each investment's expected rate of return using the Capital
Asset Pricing Model (CAPM
b.) which investment would be most and least risky?

Risk-free rate 3.0%

Market return 10.0% 7.0%

Beta
Investment A 1.00
Investment B 1.50
Investment C 0.75
Investment D 0.20
Investment E 2.00

a.
Investment A 10.00%
Investment B 13.50%
Investment C 8.25%
Investment D 4.40%
Investment E 17.00%

b. Investment E is most risky

Investment D would be less risky because it's B is least below 1.0

1 MicroMacro Stock pays a dividend of $.25 per quarter and it's

current stock price is $36.50. What is MicroMacro's dividend
yield?

Dividend per quarter $ 0.25

Annual dividend $ 1.00
Stock price $36.50
Dividend yield 2.74% dividend / stock price

2 MicroMacro's net income for the year is $525,000,000 and it

pays $40,000,000 in preferred stock dividends. MicroMacro has
250,000,000 common shares outstanding.

a What is the net income available for common shareholders?

Total net income 525,000,000

Preferred dividends 40,000,000
Net income available to common shareholders 485,000,000.00 net income - preferred dividends

b. What is the EPS per share for common shareholders?

Net income available to common shareholders 485,000,000.00

Common shares outstanding 250,000,000
EPS $ 1.94 common shareholder net income / shares outstanding

c. Using the information in Problem 1 above, what is MicroMacro's dividend payout ratio?

EPS $ 1.94
Dividend Payment $ 1.00
Payout ratio 51.5% dividend payment / EPS

3 You are provided with the following information:

Total Assets $500,000,000

Total debt $225,000,000
Preferred stock equity $50,000,000
Common stockholders equity $225,000,000
Net Income $45,000,000
# of Preferred shares outstanding 2,000,000
# of Common shares outstanding 20,000,000
Preferred Dividends paid per share $2.00
Common Dividends paid per share $1.00
Market price of preferred stock $26.00
Market price of common stock $50.00

Calculate the following:

a. The company's book value per common share share $ 11.25

b. EPS available to common shareholders $ 2.05

c. Dividend payout ratio (common stock) 48.8%

d. Common stock dividend yield 2.00%

e. Preferred stock dividend yield 7.69%

f. P/E Ratio 24.39

1 Given the following information:

Shares outstanding 1,500,000

Dividend paid per share (annual) $1.50
Net Income $6,250,000 7000000
Stock Price $75.00

Answer the following:

i.) What is the earnings per share (EPS)?

ii.) What is the dividend yield?
iii.) What is the P/E ratio?
iv.) Assuming the P/E ratio remains unchanged, what will the stock price be if the Net Income increases to $7,000,000?

i. EPS calc. $4.17 (net income - dividends) / shares outstanding

ii. Dividend yield calc. 2.0% annual dividends received per share / current market price of stock

iii. P/E ratio calc. 18.0 stock price / EPS

iv. Price at higher NI calc $84.00 ((net income - dividends)/shares o/s)*P/E ratio

2 A company's stock is trading at a P/E of 14. It announces that it expects that sales of a new product will be much more robust than
expected. As a result, management believes that future earnings should grow at a significantly higher rate than previously expected.
(i.) What would be the expected impact on the company's P/E ratio? Higher, lower, no change?
(ii.) What is your reasoning for your answer in (i.)?
(iii.) What would be the expected impact on the stock price?
(iv.) If the P/E and stock price react differently than you had expected, why might that be? (there is no correct answer to this last
question, but there are many credible answers, so think about it and be (realistically) creative if necessary; no martian invasions please).

I. Higher P/E

ii. Given higher expected future earnings, the market would likely increase the P/E to recognize higher NPV of future earnings. Since growth
companies usually have higher P/Es, this news show result in a higher P/E ratio than before
iii. Applying higher P/E ratio to EPS will result in higher stock price

iv. It could be because investors did not believe the product would sell as well as the company expects, so there was no change in investor
expectations (so P/E wouldn't increase)

1 You have been asked by your friend, the CEO of a small local company on which no research is available, to develop
a ballpark estimate of what the current value of the company might be. You decide to estimate the value of the
company by using the data you have been provided by the CEO for 2021, along with the following answers he has
provided to follow-up questions you had.

1. The revenue growth rate for each of the next 5 years is expected to be 15%.
2. Pretax profit margins and the tax rate are not expected to change.
3. The incremental operating capital required to support growth is expected to be 8% of revenue.
4. After 5 years, he is very uncertain about prospects so he expects the company may not grow any further, but will
continue to maintain the Year 5 performance indefinitely.
5. He believes that a reasonable return on similar investments would be 12%.

What is your assessment of the estimated value of your friend's company based on this information?

2022 Actual 2023 Est. 2024 Est. 2025 Est. 2026 Est. 2027 Est.
15% Revenue 10,000,000 11,500,000 13,225,000 15,208,750 17,490,063 20,113,572
10% Profit Before Tax 1,000,000 1,150,000 1,322,500 1,520,875 1,749,006 2,011,357
21% Taxes (210,000) (241,500) (277,725) (319,384) (367,291) (422,385)
Profit After Tax 790,000 908,500 1,044,775 1,201,491 1,381,715 1,588,972
8% Operating Cap'l Adjustment (120,000) (138,000) (158,700) (182,505) (209,881)
Operating Cash Flow 788,500 906,775 1,042,791 1,199,210 1,379,091
12% Terminal Value Estimate 0 0 0 0 13,241,435 With no g
as a perp
NPV of cashflows $3,713,784.66 perpetuit
formula s
PV of Terminal Value $7,513,545.72 --> use PV then add a - in front model, w
Total Value $11,227,330.38 in operati

2 The stock price, EPS and expected EPS growth rate for Companys A & B are provided below.
a.) Calculate the P/E ratio for each stock.
b.) Calculate the PEG ratio for each stock.
c.) Calculate the estimated EPS in 5 years for each stock.
d.) Calculate the P/E in 5 years for each stock, assuming that the stock price does not change.
e.) Which stock looks like a better investment value
Co. based
A on the answer
Co. to
B (d)? Briefly explain why.
f.) What would you expect to happen to the stock prices of each company over the next 5 years (assume no
systematic risk issues arise) if you don't think they will remain unchanged. Just provide a few sentences as to
what will happen and why - feel free to wager a price estimate at the end of Yr 5 for each as well!

what will happen and why - feel free to wager a price estimate at the end of Yr 5 for each as well!

Co. A Co. B
Stock Price $36.00 $75.00
EPS - current $3.00 $3.00
a. PE ratio 12.00 25.00 stock price / EPS

EPS est. Annual Growth Rate - 5 years 8% 25%

b. PEG ratio 1.50 1.00 (P/E) / EPS

c. EPS in 5 years $4.41 $9.16 EPS * ( 1 + Growth Rate)^# years

d. P/E ratio in 5 years if price unchanged 8.2 8.2 stock price / EPS

E. Company B is better because EPS is growing faster but market does not
expect growth

f. A will grow slower than B because it is more expensive. You would expect B to
have higher PEG ratio than A, assuming the EPS groth is accepted as reasonable
by investors. So A PEG should shrink and B PEG should increase

3 You are deciding between two dividend paying stocks, one whose dividend is constant (Co. Z) and another whose dividend is
growing steadily (Co. A). Using the information provided below for each company, determine the following:
(i) what the stock would be worth to you at your required rate of return.
(ii) What is the trailing and the forward dividend yield based on the current stock price.
(iii) Based on the current stock price, should you buy the stock?

Co. Z Co. A
Recent dividend paid $ 3.00 $ 4.00
Dividend growth rate 0% 5%
Your required rate of return 8% 10%
(i) Value of stock $ 37.50 $ 84.00

Current stock price $ 40.00 $ 60.00

(ii) Trailing Dividend yield 7.5% 6.7%
Forward Dividend yield no div. growth rate 7.5% 7.0%

(iii) Buy Stock? (Y/N) no yes pay $60 for stock valued at $84

growth , the terminal value calc is the same

petuity, using the profit after tax as the
ty payment. With growth, you would use a
similar to the dividend growth valuation
with a little more complexity due to changes
ting capital/cashflow.

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