Chapter 4: Q.20I (page 398)
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
Answer
a. General Autos
b. Friendly Airlines
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The SEC due-diligence team is searching for the reason behind Hatfield’s inventory build-up relative to its sales growth. One way to identify a deliberate manipulation of financial results by Hatfield is to search for:
a. A decline in inventory turnover.
b. Receivables that are growing faster than sales.
c. A delay in the recognition of expenses.
OceanGate sells external hard drives for \(200 each. Its total fixed costs are \)30 million, and its variable costs per unit are $140. The corporate tax rate is 30%. If the economy is strong, the firm will sell 2 million drives, but if there is a recession, it will sell only half as many. What is the firm’s degree of operating leverage? If the economy enters a recession, what will be the firm’s after-tax profit?
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?
Even Better Products has come out with a new and improved product. As a result, the firm projects an ROE of 20%, and it will maintain a plowback ratio of .30. Its earnings this year will be $2 per share. Investors expect a 12% rate of return on the stock.
a. At what price and P/E ratio would you expect the firm to sell?
b. What is the present value of growth opportunities?
c. What would be the P/E ratio and the present value of growth opportunities if the firm planned to reinvest only 20% of its earnings?
Here are four industries and four forecasts for the macro-economy. 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.
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