Finance Ch 9 and 13 Problems Set
Question # 00050263
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Updated on: 02/23/2015 10:42 AM Due on: 02/25/2015
1. Chapter 9: problem sets, numbers 11, 12, 18 and 20, and CFA problems, numbers 3 and 5
2. Chapter 13: problem sets, numbers 10, 11, 16, 17, 19, and 20, and CFA problems, numbers 4 and 6
APA format is not required, but solid academic writing is expected.
2. Chapter 13: problem sets, numbers 10, 11, 16, 17, 19, and 20, and CFA problems, numbers 4 and 6
APA format is not required, but solid academic writing is expected.
11. Even if prices follow a random walk, they still may not be informationally efficient.
Explain why this may be true, and why it matters for the efficient allocation of capital in
our economy. (LO 9-2)
12. What is meant by “limits to arbitrage”? Give some examples of such limits.
18. Table 9.3 presents price data for Computers, Inc., and a computer industry index. Does
Computers, Inc., show relative strength over this period?
20. Construct a point and figure chart for Computers, Inc., using again the data in
Table 9.3 . Use $2 increments for your chart. Do the buy or sell signals derived from
your chart correspond to those derived from the moving-average rule (see the previous
problem)?
3. Louise and Christopher Maclin live in London, United Kingdom, and currently rent an
apartment in the metropolitan area. During an initial discussion of the Maclins’ financial
plans, Christopher Maclin makes the following statements to the Maclins’ financial
adviser, Grant Webb:
a. “I have used the Internet extensively to research the outlook for the housing market
over the next five years, and I believe now is the best time to buy a house.”
b. “I do not want to sell any bond in my portfolio for a lower price than I paid for the bond.”
c. “I will not sell any of my company stock because I know my company and I believe it
has excellent prospects for the future.”
For each statement ( a )–( c ) identify the behavioral finance concept most directly exhibited.
Explain how each behavioral finance concept is affecting the Maclins’ investment decision
making.
5. Claire Pierce comments on her life circumstances and investment outlook:
I must support my parents who live overseas on Pogo Island. The Pogo Island economy has grown
rapidly over the past two years with minimal inflation, and consensus forecasts call for a continuation
of these favorable trends for the foreseeable future. Economic growth has resulted from the
export of a natural resource used in an exciting new technology application.
I want to invest 10% of my portfolio in Pogo Island government bonds. I plan to purchase longterm
bonds because my parents are likely to live more than 10 years. Experts uniformly do not
foresee a resurgence of inflation on Pogo Island, so I am certain that the total returns produced
by the bonds will cover my parents’ spending needs for many years to come. There should be
no exchange rate risk because the bonds are denominated in local currency. I want to buy the
Pogo Island bonds but am not willing to distort my portfolio’s long-term asset allocation to do
so. The overall mix of stocks, bonds, and other investments should not change. Therefore, I am considering selling one of my U.S. bond funds to raise cash to buy the Pogo Island bonds. One
possibility is my High Yield Bond Fund, which has declined 5% in value year to date. I am not
excited about this fund’s prospects; in fact I think it is likely to decline more, but there is a small
probability that it could recover very quickly. So I have decided instead to sell my Core Bond
Fund that has appreciated 5% this year. I expect this investment to continue to deliver attractive
returns, but there is a small chance this year’s gains might disappear quickly.
Once that shift is accomplished, my investments will be in great shape. The sole exception is my
Small Company Fund, which has performed poorly. I plan to sell this investment as soon as the
price increases to my original cost.
Identify three behavioral finance concepts illustrated in Pierce’s comments and describe
each of the three concepts. Discuss how an investor practicing standard or traditional
finance would challenge each of the three concepts.
CHAPTER 13
10. Miltmar Corporation will pay a year-end dividend of $4, and dividends thereafter are
expected to grow at the constant rate of 4% per year. The risk-free rate is 4%, and the
expected return on the market portfolio is 12%. The stock has a beta of .75. What is the
intrinsic value of the stock? (L O 13-2)
11. Sisters Corp expects to earn $6 per share next year. The firm’s ROE is 15% and its
plowback ratio is 60%. If the firm’s market capitalization rate is 10%, what is the present
value of its growth opportunities?
16. Explain why the following statements are true/false/uncertain. (LO 13-3)
a. With all else held constant, a firm will have a higher P/E if its beta is higher.
b. P/E will tend to be higher when ROE is higher (assuming plowback is positive).
c. P/E will tend to be higher when the plowback rate is higher.
17. a. Computer stocks currently provide an expected rate of return of 16%. MBI, a large
computer company, will pay a year-end dividend of $2 per share. If the stock is selling
at $50 per share, what must be the market’s expectation of the growth rate of MBI
dividends?
b. If dividend growth forecasts for MBI are revised downward to 5% per year, what will
happen to the price of MBI stock? What (qualitatively) will happen to the company’s
price–earnings ratio?
19. a. MF Corp. has an ROE of 16% and a plowback ratio of 50%. If the coming year’s
earnings are expected to be $2 per share, at what price will the stock sell? The market
capitalization rate is 12%.
b. What price do you expect MF shares to sell for in three years? (LO 13-2)
20. The market consensus is that Analog Electronic Corporation has an ROE 5 9% and a
beta of 1.25. It plans to maintain indefinitely its traditional plowback ratio of 2/3. This
year’s earnings were $3 per share. The annual dividend was just paid. The consensus
estimate of the coming year’s market return is 14%, and T-bills currently offer a 6%
return. (LO 13-3)
a. Find the price at which Analog stock should sell.
b. Calculate the P/E ratio.
c. Calculate the present value of growth opportunities.
d. Suppose your research convinces you Analog will announce momentarily that it will
immediately reduce its plowback ratio to 1/3. Find the intrinsic value of the stock.
The market is still unaware of this decision. Explain why V 0 no longer equals P 0 and
why V 0 is greater or less than P 0
4. Janet Ludlow’s firm requires all its analysts to use a two-stage DDM and the CAPM to
value stocks. Using these measures, Ludlow has valued QuickBrush Company at $63 per
share. She now must value SmileWhite Corporation. (LO 13-2)
a. Calculate the required rate of return for SmileWhite using the information in the
following table:
December 2010
QuickBrush SmileWhite
Beta 1.35 1.15
Market price $45.00 $30.00
Intrinsic value $63.00 ?
Note: Risk-free rate 5 4.50%; expected market return 5 14.50%.
b. Ludlow estimates the following EPS and dividend growth rates for SmileWhite:
First three years: 12% per year
Years thereafter: 9% per year
Estimate the intrinsic value of SmileWhite using the table above and the two-stage
DDM. Dividends per share in 2010 were $1.72.
c. Recommend QuickBrush or SmileWhite stock for purchase by comparing each company’s
intrinsic value with its current market price.
d. Describe one strength of the two-stage DDM in comparison with the constant-growth
DDM. Describe one weakness inherent in all DDMs.
6. While valuing the equity of Rio National Corp. (from the previous problem), Katrina
Shaar is considering the use of either free cash flow to the firm (FCFF) or free cash flow
to equity (FCFE) in her valuation process. (LO 13-4)
a. State two adjustments that Shaar should make to FCFF to obtain free cash flow to
equity.
b. Shaar decides to calculate Rio National’s FCFE for the year 2012, starting with net
income. Determine for each of the five supplemental notes given in Table 13.7 whether
an adjustment should be made to net income to calculate Rio National’s free cash flow
to equity for the year 2012, and the dollar amount of any adjustment.
c. Calculate Rio National’s free cash flow to equity for the year 2012.
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Solution: Finance Ch 9 and 13 Problems Set Solution