Download Investment Analysis (FIN 670)

Investment Analysis (FIN 670)
Fall 2009
Homework 9
Instructions: please read carefully
•
•
You should show your work how to get the answer for each calculation question to get full
credit
The due date is Tue Dec 15, 2009. Late homework will not be graded.
Name(s):
Student ID
1. At what stage of industry life cycle a company would face an influx of competition?
a. Start-up
b. Consolidation
c. Maturity
d. Relative decline
1. c
2. ______________ is an example of a defensive industry.
a. Food producers
b. Auto manufacturers
c. Both A and B are examples.
d. Neither A nor B is an example.
2. a
3. Companies in the maturity state of the industry life cycle are sometimes referred to as
______________.
a. falling stars
b. bargains
c. turnarounds
d. cash cows
3. d
4. Which of the following will affect the sensitivity of a firm's earnings to the business cycle?
a. Operating leverage.
b. Dividend policy.
c. Tax liabilities.
d. None of the above will.
4. a
5. According to the section rotation analysis, investors should invest more heavily in ______________
when the economy enters a contraction stage.
a. cyclical industry
b. defensive industry
c. Either industry.
d. Both industries.
5. b
6. Which of the following is a characteristic of the start-up stage of the industry life cycle?
a. New technology.
b. Many competitors.
c. Slow growth.
d. Dominant industry leader.
6. a
7. Which of the following is true about industry analysis?
a. When the economy is booming, rates of return across industry do not vary greatly.
b. When the economy is weak, rates of return across industry do not vary greatly.
c. Rates of return across industry vary during a specific period of time.
d. Rates of return across industry do not vary over time
7. c
8. When the Federal Reserve ______________ the discount rate, the money supply of the economy will
increase.
a. Raises
b. Lowers
c. does not change
d. None of the above.
8. b
9. What is the first step of a proper top-down analysis of a company's prospects?
a. The analysis of the global economy.
b. The analysis of the domestic economy.
c. The analysis of the industry the company is in.
d. The analysis of the company's fundamentals.
9. a
10. Fiscal policy refers to the government's ______________ to stabilize the economy.
a. influence of money supply and demand
b. trading policy
c. technology development
d. spending and taxing
10. d
11. ______________ are indicators whose values reach troughs and peaks before the aggregate economy
does.
a. Front-running indicators
b. Lagging indicators
c. Leading indicators
d. First indicators
11. c
12. Monetary policy refers to the government's ______________ to change investment and consumption
demand.
a. manipulation of money supply
b. taxing policy
c. exchange rate policy
d. interstate business policy
12. a
Use the following to answer questions 13-16:
An industry analysis for manufacturers of a small personal care gadget observed the following
characteristics:
• Industry sales have grown at 15-20% per year in recent years are expected to grow at 10-15% per
year over the next three years.
• Some U.S. manufacturers are attempting to enter fast growing non-U.S. markets, which remain
largely unexploited.
• Some manufacturers have created a new niche in the industry by selling directly to customers through
mail order. Sales for this industry segment are growing at 40% per year.
• The current penetration rate in the U.S. is 60% of households and will be difficult to increase.
•
•
•
•
Manufacturers compete fiercely on the basis of price, and price wars within the industry are common.
Some manufacturers are able to develop new, unexploited niche markets in the U.S. based on
company reputation, quality, and service.
Several manufacturers have recently merged, and it is expected that consolidation in the industry will
increase.
New manufacturers continue to enter the market.
13.
Characteristics 4 and 5 would indicate that the industry is in the ___ stage.
A) Start-up
B) Consolidation
C) Maturity
D) Relative decline
13. c
14. Characteristics ____ would be typical of an industry that is in the start-up stage.
A) 4 and 7
B) 1 and 4
C) 2 and 5
D) none of the above
14. d
15. Characteristics ____ would be typical of an industry that is in the consolidation stage.
A) 6 and 7
B) 1 and 4
C) 5 and 6
D) none of the above
15. a
16.Characteristics ____ would be typical of an industry that is in the maturity stage.
A) 1, 2 and 3
B) 4 and 5
C) 6, 7 and 8
D) none of the above
16.b
17. Consider two firms producing DVDs. One uses a highly automated robotic process, while the other
use human workers on an assembly line and pays over time where there is heavy production demand.
a. Which firm will have higher profits in a recession? In a boom? Explain briefly
The robotics process entails higher fixed costs and lower variable (labor) costs. Therefore,
this firm will perform better in a boom and worse in a recession. For example, costs
will rise less rapidly than revenue when sales volume expands during a boom.
b. Which firm’s stock will have higher beta. Explain briefly
Because its profits are more sensitive to the business cycle, the robotics firm will have the higher
beta.
18. For each pair of firms, choose the one that you think would be more sensitive to the business cycle
a. General Autos or General Pharmaceuticals. Explain briefly.
General Autos.
Pharmaceutical goods essential so they are not very affected by business cycles
b. Friendly Airlines or Happy Cinemas. Explain briefly.
Friendly Airlines. Travel expenditures are more sensitive to the business cycle than movie
consumption.
19. Here are four industries and four forecasts for the macroeconomy. Choose the industry that you
would expect to perform best in each scenario.
Industries: Housing construction, health care, gold mining, steel production.
Economic Forecasts:
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.
a.
Housing construction (cyclical but interest-rate sensitive): (iii) Healthy expansion
b.
Health care (a non-cyclical industry): (i) Deep recession
c.
Gold mining (counter-cyclical): (iv) Stagflation
d.
Steel production (cyclical industry) (ii) Superheated economy
20. If you believe the U.S. dollar is about to depreciate more dramatically than do other investors, what
will be your stance on investments in U.S. auto producers?
A depreciating dollar makes imported cars more expensive and American cars less expensive to
foreign consumers. This should benefit the U.S. auto industry.
21. A firm ______________ its ROE by using more debt in its capital structure.
a. can increase
b. can decrease
c. cannot change
d. More information is required.
21. d (since ROE depends on ROA, tax, and capital structure which is debt/equity)
22. A company in a 30% tax bracket will have a margin of ______________ if its ROA is 16% and asset
turnover is 2.
a. 8%
b. 10%
c. 16%
d. 30%
22.a
ROA = EBIT/total asset = 0.16
Asset turnover = sale/total asset = 2
We need to calculate margin = EBIT/sale
If we divide ROA by asset turnover, the total asset will cancel out,
So m arg in =
EBIT
EBIT
total _ asset
1
0.16
=
×
= ROA ×
=
= 0.08
sale
total _ asset
sale
asset _ turnover
2
23. What is a company's debt to equity ratio if its asset to equity ratio is 2?
a. 0.5
b. 1
c. 2
d. 2.5
Asset
Debt + equity
Debt
=
=
+1
Equity
Equity
Equity
Debt
Asset
=
−1 = 2 −1 = 1
Equity Equity
24. National Furniture Company has an ROE of 11.9%, a debt/equity ratio of 2/3, a tax rate of 30%, and
an interest rate on its debt of 12%. Its ROA is
a. 12%
b. 15%
c. 20%
d. 24%
24.b
⎡
Debt ⎤
ROE = (1 − TaxRate) ⎢ ROA + ( ROA − InterestRate)
Equity ⎥⎦
⎣
2⎤
⎡
11.9 = (1 − 0.3) ⎢ ROA + (ROA − 12) × ⎥
3⎦
⎣
Solve for ROA = 15%
25. The Asset Turnover of a company can be improved by ______________.
a. cutting operating expenses
b. investing more efficiently with its assets
c. borrowing more debt
d. cutting operating and interest expenses
25.b
The asset turnover ratio tells how efficient a company is using its asset to generate sale
26. What is the most correct relationship between a company's ROE and ROA when the company does
not borrow any debt?
a. ROE > ROA
b. ROE = ROA
c. ROE < ROA
d. ROE = (1 + T)ROA
⎡
Debt ⎤
ROE = (1 − TaxRate) ⎢ ROA + ( ROA − InterestRate)
Equity ⎥⎦
⎣
When there is no debt, we have
ROE = (1 − TaxRate) ROA
Since 1 - Tax rate < 1,
therefore ROA has to be higher than ROE
27. The capital structure of a company can be determined by using information from ______________.
a. the income statement
b. the cash flow statement
c. the balance sheet
d. None of the above.
27. c (capital structure is how much debt and equity the company is using)
28.
Which of the following balance sheet items is not considered an asset?
A) inventory
B) accounts receivable
C) accrued taxes
D) All of the above are assets
28. c
29.
A firm has a ROE of 20% and a market-to-book ratio of 2.38. Its P/E ratio is __________.
A) 8.40
B) 11.90
C) 17.62
D) 47.60
Net income (or earning)
= 0.2
total equity
If we divide both numerator and denominator by the number of shares outstanding, we have
ROE =
Net income (or earning)/number of shares outstanding earning per share (EPS)
=
= 0.2
total equity/number of shares outstanding
book value per share
price per share
= 2.38
market - to - book ratio =
book value per share
book value per share
price per share
price per share
=
×
P/E ratio =
EPS
book value per share
EPS
1
= market - to - book ratio ×
ROE
2.38
=
= 11.9
0.2
ROE =
Use the following to answer questions 30-33:
The financial statements of Shuswap Lake Manufacturing Company are given below.
Note: The common shares are trading in the stock market for $160 each.
30.
The firm's current ratio for 2005 is __________.
A) 0.90
B) 1.44
C) 1.89
D) 2.80
CR =
1,150,000
= 1.44
800,000
31.
The firm's leverage ratio for 2004 is __________.
A) 0.90
B) 1.56
C) 1.89
D) 3.13
2,500,000
L=
= 3.13
200,000 + 600,000
32.
The firm's fixed asset turnover ratio for 2005 is __________. Please keep in mind that when a
ratio involves both income statement and balance sheet numbers, the balance sheet numbers for
the beginning and end of the year must be averaged.
A) 3.39
B) 3.60
C) 6.00
D) 12.00
5,000,000
FAT =
= 3.39
1,400,000 + 1,550,000
2
33.
The firm's asset turnover ratio for 2005 is__________. Please keep in mind that when a ratio
involves both income statement and balance sheet numbers, the balance sheet numbers for the
beginning and end of the year must be averaged.
A) 0.90
B) 1.56
C) 1.92
D) 2.80
5,000,000
AT =
= 1.92
2,500,000 + 2,700,000
2
34.
The net income of the company is $970. Taxes payable decrease by $120, depreciation is $85,
and fixed assets are sold for $90. If the firm's inventories also decline by $65, what is the total
change in cash for the firm for all activities?
A) Increase of $970
B) Increase of $1090
C) Decrease of $970
D) Decrease of $1090
cash flow = 970 - 120 + 85 + 90+ 65 = 1090
35. Yesterday, Bicksler Corporation purchased (and received) raw materials on credit from its supplier.
All else equal, if Bicksler’s current ratio was 2.0 before the purchase, what effect did this transaction
have on Bicksler’s current ratio?
a. increased
b. decreased
c. stayed the same
d. There is not enough information to answer this question.
e. None of the above is a correct answer.
35. b
The company purchased on credit, so this will increase account payable or current liabilities, so the
current ratio would decrease
36. The Crusty Pie Co., which specializes in apple turnovers, has a return on sales higher than the
industry average, yet its ROA is the same as the industry average. How can you explain this?
ROA = (EBIT/Sales) × (Sales/Total Assets) = ROS × ATO
The only way that Crusty Pie can have an ROS higher than the industry average and an
ROA equal to the industry average is for its ATO to be lower than the industry average.
37. The ABC Corporation has a profit margin on sales below the industry average, yet its ROA is above
the industry average. What does this imply about its asset turnover?
ABC’s asset turnover must be above the industry average.
38. Jones Group has been generating stable after-tax return on equity (ROE) despite declining operating
income. Explain how it might be able to maintain its stable after-tax ROE.
Since ROE is a function of net profit and equity, it is possible to maintain a stable ROE,
while net profits decline so long as equity also declines proportionally.
39. A company’s current ratio is 2.0. If the company uses cash to retire notes payable due within one year,
would this transaction increase or decrease the current ratio? What about the asset turnover ratio?
This transaction would increase the current ratio. The transaction reduces both current
assets and current liabilities by the same amount, but the reduction has a larger
proportionate impact on current liabilities than on current assets. Therefore, the current
ratio would increase.
This transaction would increase the asset turnover ratio. Sales should remain unaffected,
but assets are reduced.
40. The financial statements for Chicago Refrigerator Inc. are to be used to compute the ratios a through h for
2005.
a. Quick ratio.
Cash + receivables
$325 + $3599
Quick Ratio = Current liabilities =
= 0.99
$3945
b. Return on assets.
ROA =
=
EBIT Net income before tax + interest expense
=
Average assets
Assets
$2259 + $78
= 0.364 = 36.4%
0.5 × ($8058 + $4792)
c. Return on common shareholders’ equity.
a. ROE =
ROE =
Net income
Average common equity
Net income
$1265
=
= 1.835
Average common equity 0.5 × ($550 + $829)
d. Earnings per share of common stock.
Earnings per share =
$1265
= $1.53
(829)
e. Profit margin.
Profit margin =
f.
EBIT $2259 + $78
=
= 0.194 = 19.4%
Sales
$12065
ԜTimes interest earned.
Times interest earned =
EBIT
$2259 + $78
=
= 30.0
Interest expense
$78
g. Inventory turnover.
Inventory turnover =
Cost of goods sold
$8048
=
= 4.19
Average inventory 0.5 × ($1415 + $2423)
h. Leverage ratio.
Leverage ratio =
Average assets
0.5 × ($4792 + $8058)
=
= 2.25
Average common equity 0.5 × ($2368 + $3353)
41 Scott Kelly is reviewing MasterToy’s financial statements in order to estimate its sustainable
.
growth rate. Using the information presented in Table 41A
TABLE
41A
Mastertoy, Inc.: Actual 2004 and estimated 2005 financial statements
for fiscal year ending December 31 ($ millions, except per-share data)
a. Identify and calculate the components of the DuPont formula.
a. ROE =
Net profit
=
Equity
Net profit
Pretax profit EBIT Sales Assets
×
×
×
×
Pretax profit
EBIT
Sales Assets Equity
= Tax-burden × Interest burden × Profit margin × Asset turnover
× Leverage
Tax burden =
Net profit
$510
=
= 0.6335
Pretax Profit $805
Interest burden =
Profit margin =
EBIT $830
=
= 0.1615
Sales $5140
Asset turnover =
Leverage =
Pretax profit $805
=
= 0.9699
EBIT
$830
Sales $5140
=
= 1.6581
Assets $3100
Assets $3100
=
= 1.4091
Equity $2200
b. Calculate the ROE for 2005 using the components of the DuPont formula.
b. ROE = 0.6335 × 0.9699 × 0.1615 × 1.6581 × 1.4091 = 0.2318 =
23.18%
c. Calculate the sustainable growth rate for 2005 from the firm’s ROE and plowback
ratios.
g = ROE × plowback = 0.2318 ×
1.96 − 0.60
= 0.1608 = 16.08%
1.96