Relative price of chocolates and relative price of stock

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Reference no: EM131850724

1. a. If one box of chocolates made by firm A cost $30 and a box made by firm B costs $10, then which chocolates are more expensive? Now, con- sider that firm A’s box holds 5 pounds of chocolates and firm B’s box holds 1 pound of chocolates. Whose chocolates are more expensive, given this new information? Why might consumers be willing to pay more per pound for B’s chocolates?

b. Let’s say that one share of Acme stock is selling for $250 and one share of Zeta stock is selling for $15. Which stock is more expensive? Consider that EPS for Acme was $100 last year and EPS for Zeta was $1. What is the P/E for Acme and the P/E for Zeta? Now which stock do you think is more ex- pensive? Why do you think Zeta may have a higher P/E than Acme?

c. Is there some similarity between the story of the relative price of chocolates and the relative price of the stock? Explain.

2. Suppose your father owns a stock that he feels has done very well. “In fact,” he says, “it went up 18% last year!” Do you think that 18% was good per- formance? How would you go about deciding whether 18% was good, bad, or mediocre for the past 12 months?

3. A corporation has decided to change its depreciation method to write off assets over a longer term. Thus, each year depreciation expense will be significantly lower, although nothing else about the business will be materially different. What do you think will happen to the firm’s financial results because of this change? (Hint: Consider changes in depreciation expense, net income, net profit margin, ROE, ROA, and any others you wish to comment on.) What happens to cash flow because of this change?

4. Artistic Designs, Inc. has a current ratio of 3.0. What would be the impact on the current ratio if the company

a. used cash to pay off some current debt

b. used cash to repurchase some outstanding shares of stock

c. used cash to pay a dividend

d. borrowed cash from a local bank to purchase a company-owned automobile. The loan is short-term, due in six months.

e. borrowed short term and uses the funds to increase inventory.

5. Dan Jones, the treasurer at Acme Industries, notices that the firm keeps sev- eral million dollars in marketable securities invested in very short-term trea- sury securities. Maturities are from 1 week to 3 weeks. Dan notices that by investing in longer-term government securities, the company can earn, on av- erage, one full percentage point more income on the marketable securities ac- count balance. Let’s assume that Dan implements his strategy and invests in government bonds with 10-year maturities.

a. What would happen if market interest rates suddenly rose (remember the teeter-totter of bond values from Chapter 5)?

b. What impact would Dan’s decision have on ROE if interest rates didn’t rise immediately and the long-term bonds raised income?

c. What impact would Dan’s decision have on the riskiness of the firm?

d. If stockholders knew of Dan’s action, what impact do you think it would have on their valuation of the firm?

6. Honest John’s Used Cars began an advertising campaign stating, “We’ll sell you a car. We’ll finance it. And we won’t check your credit.” John’s car lot went crazy with business. John knew he was taking some big risks by lending money to anybody, but he reasoned that he could increase his sales prices to improve his margins and pay for the inevitable increase in bad debt losses. Explain what you think will happen to Honest John’s asset turnover, inven- tory turnover, and days sales outstanding, and explain your reasoning. What do you think will happen to Honest John’s net income?

7. Borrowers pay thousands of dollars to have their bond issue rated by Standard & Poor’s or Moody’s. Why would borrowers pay so much for these an- alysts’ opinions and their publication? (Hint: Why might investing in having your bonds rated be a positive NPV project?)

8. Some business people have advocated gaining market share as a good indica- tor of firm performance. What’s your opinion of this idea? (Hint: How could a company easily increase its market share, perhaps to 100%? Would this tactic be good business?)

Reference no: EM131850724

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