Chapter 4: Q14I (page 476)
A firm has a tax burden ratio of .75, a leverage ratio of 1.25, an interest burden of .6, anda return on sales of 10%. The firm generates $2.40 in sales per dollar of assets. What isthe firm’s ROE?
ROE = 13.5%
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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
b. Friendly Airlines or Happy Cinemas
Use the following case in answering Problems 26 – 28:
Institutional Advisors for All Inc., or IAAI, is a consulting firm that primarily advises all types of institutions such as foundations, endowments, pension plans, and insurance companies. IAAI also provides advice to a select group of individual investors with large portfolios. One of the claims the firm makes in its advertising is that IAAI devotes considerable resources to forecasting and determining long-term trends; then it uses commonly accepted investment models to determine how these trends should affect the performance of various investments. The members of the research department
of IAAI recently reached some conclusions concerning some important macroeconomic trends. For instance, they have seen an upward trend in job creation and consumer confidence and predict that this should continue for the next few years. Other domestic leading indicators that the research department at IAAI wishes to consider are industrial production, average weekly hours in manufacturing, S&P 500 stock prices, M2 money supply, and the index of consumer expectations.
In light of the predictions for job creation and consumer confidence, the investment advisers at IAAI want to make recommendations for their clients. They use established theories that relate job creation and consumer confidence to inflation and interest rates and then incorporate the forecast movements in inflation and interest rates into established models for explaining asset prices. Their primary concern is to forecast how the trends in job creation and consumer confidence should affect bond prices and how those trends should affect stock prices.
The members of the research department at IAAI also note that stocks have been trending up in the past year, and this information is factored into the forecasts of the overall economy than they deliver. The researchers consider an upward-trending stock market a positive economic indicator in itself; however, they disagree as to the reason this should be the case.
The researchers at IAAI have forecast positive trends for both job creation and consumer confidence. Which, if either, of these trends, should have a positive effect on stock prices?
A firm has current assets that could be sold for their book value of \(10 million. The book value of its fixed assets is \)60 million, but they could be sold for \(90 million today.
The firm has total debt with a book value of \)40 million, but interest rate declines have caused the market value of the debt to increase to $50 million. What is this firm’s market-to-book ratio?
What monetary and fiscal policies might be prescribed for an economy in a deep recession?
Choose an industry and identify the factors that will determine its performance in the next three years. What is your forecast for performance in that period?
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