3 PROBLEMS ON FINANCIAL ECONOMICS

QUESTIONS :

 

10. Leland Manufacturing Company anticipates a noncontact growth pattern for dividends. Dividends at the end of year 1 are $4.00 per share and are expected to grow by 20 percent per year until the end of year 4 (that’s three years of growth). After year 4, dividends are expected to grow at 5 percent as far as the company can see into the future. All dividends are to be discounted back to present at a 13 percent rate (K
e = 13 percent).

• a. Project dividends for years 1 through 4 (the first year is already given). Round all values that you compute to two places to the right of the decimal point throughout this problem.
• b. Find the present value of the dividends in part a.
• c. Project the dividend for the fifth year (D5).
• d. Use Formula 7–5 on page 168 to find the present value of all future dividends, beginning with the fifth year’s dividend. The present value you find will be at the end of the fourth year. Use Formula 7–5 as follows: P4 = D5/(Ke − g).
• e. Discount back the value found in part d for four years at 13 percent.
• f. Add together the values from parts b and e to determine the present value of the stock.

   

14. Mr. Phillips of Southwest Investment Bankers is evaluating the P/E ratio of Madison Electronics Conveyors (MEC). The firm’s P/E is currently 17. With earning per share of $2, the stock price is $34.

The average P/E ratio in the electronic conveyor industry is presently 16. However, MEC has an anticipated growth rate of 18 percent versus an industry average of 12 percent, so 2 will be added to the industry P/E by Mr. Phillips. Also, the operating risk associated with MEC is less than that for the industry because of its long-term contract with American Airlines. For this reason, Mr. Phillips will add a factor of 1.5 to the industry P/E ratio.

The debt-to-total-assets ratio is not as encouraging. It is 50 percent, while the industry ratio is 40 percent. In doing his evaluation, Mr. Phillips decides to subtract a factor of 0.5 from the industry P/E ratio. Other ratios, including dividend payout, appear to be in line with the industry, so Mr. Phillips will make no further adjustment along these lines.

However, he is somewhat distressed by the fact that the firm only spent 3 percent of sales on research and development last year, when the industry norm is 7 percent. For this reason he will subtract a factor of 1.5 from the industry P/E ratio.

Despite the relatively low research budget, Mr. Sanders observes that the firm has just hired two of the top executives from a competitor in the industry. He decides to add a factor of 1 to the industry P/E ratio because of this.

• a. Determine the P/E ratio for MEC based on Mr. Phillips’s analysis.
• b. Multiply this times earnings per share, and comment on whether you think the stock might possibly be under- or overvalued in the marketplace at its current P/E and price.

   

15. The Multi-Corporation has three different operating divisions. Financial information for each is as follows:

  

a. Which division provides the highest operating margin?b. Which division provides the lowest after-tax profit margin?c. Which division has the lowest after-tax return on assets?d. Compute net income (after-tax) to sales for the entire corporation.e. Compute net income (after-tax) to assets for the entire corporation.f. The vice president of finance suggests the assets in the Appliances division be sold off for $10 million and redeployed in Sporting Goods. The new $10 million in Sporting Goods will produce the same after-tax return on assets as the current $8 million in that division. Recompute net income to total assets for the entire corporation assuming the above suggested change.g. Explain why Sporting Goods, which has a lower return on sales than Appliances, has such a positive effect on return on assets.