Chapter 4: Q2B (page 436)
In what circumstances is it most important to use multistage dividend discount models rather than constant-growth models?
To value the companies with temporarily high growth rates.
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Use the following case in answering Problems 9– 11:
Hatfield Industries is a large manufacturingconglomerate based in the United States with annual sales in excess of $300 million.
Hatfield is currently under investigation by the Securities and Exchange Commission (SEC)for accounting irregularities and possible legal violations in the presentation of the company’sfinancial statements. A due-diligence team from the SEC has been sent to Hatfield’s corporateheadquarters in Philadelphia for a complete audit in order to further assess the situation.
Several unique circumstances at Hatfield are discovered by the SEC due-diligence teamduring the course of the investigation:
The SEC due-diligence team is not necessarily searching for evidence of fraud but of possiblemanipulation of accounting standards for the purpose of misleading shareholders and otherinterested parties. Initial review of Hatfield’s financial statements indicates that, at a minimum,certain practices have resulted in low-quality earnings.
Question: Labor officials believe that the management of Hatfield is attempting to understate its netincome to avoid making any concessions in the labor negotiations. Which of the followingactions by management will most likely result in low-quality earnings?
a. Lengthening the life of a depreciable asset in order to lower the depreciation expense.
b. Lowering the discount rate used in the valuation of the company’s pension obligations.
c. The recognition of revenue at the time of delivery rather than when payment is received.
The FI Corporation’s dividends per share are expected to grow indefinitely by 5% per year.
a. If this year’s year-end dividend is \(8 and the market capitalization rate is 10% per year, what must the current stock price be according to the DDM?
b. If the expected earnings per share are \)12, what is the implied value of the ROE on future investment opportunities?
c. How much is the market paying per share for growth opportunities (that is, for an ROE on future investments that exceeds the market capitalization rate)?
What is typically true of corporate dividend payout rates in the early stages of an industry life cycle? Why does this make sense?
Cash flow from operating activities includes:
a. Inventory increases resulting from acquisitions.
b. Inventory changes due to changing exchange rates.
c. Interest paid to bondholders.
d. Dividends paid to stockholders.
Use the following case in answering Problems 29 – 32:
Mary Smith, a Level II CFA candidate, was recently hired for an analyst position at the Bank of Ireland. Her first assignment is to examine the competitive strategies employed by various French wineries.
Smith’s report identifies four wineries that are the major players in the French wine industry. The key characteristics of each are cited in Table 12.6. In the body of Smith’s report, she includes a discussion of the competitive structure of the French wine industry. She notes that over the past five years, the French wine industry has not responded to changing consumer tastes. Profit margins have declined steadily, and the number of firms representing the industry has decreased from 10 to 4. It appears that participants in the French wine industry must consolidate in order to survive.
Smith’s report notes that French consumers have strong bargaining power over the industry.
She supports this conclusion with five key points, which she labels “Bargaining Power of Buyers”:
After completing the first draft of her report, Smith takes it to her boss, RonVanDriesen, to review. VanDriesen tells her that he is a wine connoisseur himself and often makes purchases from the South Winery. Smith tells VanDriesen, “In my report, I have classified the South Winery as a stuck-in-the-middle firm. It tries to be a cost leader by selling its wine at a price that is slightly below the other firms, but it also tries to differentiate itself from its competitors by producing wine in bottles with curved necks, which increases its cost structure. The end result is that the South Winery’s profit margin gets squeezed from both sides.” VanDriesen replies, “I have met members of the management team from the South Winery at a couple of the wine conventions I have attended. I believe that the South Winery could succeed at following
both cost leadership and a differentiation strategy if its operations were separated into distinct operating units, with each unit pursuing a different competitive strategy.” Smith makes a note to do more research on generic competitive strategies to verify VanDriesen’s assertions before publishing the final draft of her report.
Which of Smith’s points effectively supports the conclusion that consumers have strong bargaining power over the industry?
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