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Essentials Of Investments
Found in: Page 441
Essentials Of Investments

Essentials Of Investments

Book edition 9th
Author(s) Zvi Bodie, Alex Kane, Alan Marcus, Alan J. Marcus
Pages 748 pages
ISBN 9780078034695

Short Answer

Rio National Corp. is a U.S.-based company and the largest competitor in its industry. Tables 13.5 – 13.8 present financial statements and related information for the company.

Table 13.9 presents relevant industry and market data.

The portfolio manager of a large mutual fund comments to one of the fund’s analysts, Katrina Shaar: “We have been considering the purchase of Rio National Corp. equity shares, so I would like you to analyze the value of the company. To begin, based on

Rio National’s past performance, you can assume that the company will grow at the same rate as the industry.”

a. Calculate the value of a share of Rio National equity on December 31, 2012, using the constant-growth model and the capital asset pricing model.

b. Calculate the sustainable growth rate of Rio National on December 31, 2012. Use 2012 beginning-of-year balance sheet values.

a. 13% and $22.40

b. 9.97%

See the step by step solution

Step by Step Solution

Step 1: Calculation of required rate of return ‘a’

The value of a share of Rio National equity = $22.40,

Formulae

k = rf + β [E(rM) – rf ] (Constant Growth model)

= 0.04 + 1.8 x (0.09 – 0.04)

= 0.13 or 13%

The share value (Gordon growth model):

P0 = D0 x (1 + g) / k – g

= $0.20 x (1 + 0.12) / 0.13 – 0.12

= $22.40

Step 2: Calculation of sustainable growth rate ‘b’

g = ROE × b

= ROE × Retention Rate

= ROE × (1 – Payout Ratio)

= (1 – Dividend / Net income) x Net income / Beginning equity

= (1 - $3.20) / $30.16 x $30.16 / $270.35

= 0.0997

= 9.97%

Most popular questions for Business-studies Textbooks

Adams’s research report (see the previous problem) continued as follows: “With a business expansion already under way, the expected profit surge should lead to a much higher price for Universal Auto stock. We strongly recommend purchase.”

a. Discuss the business-cycle approach to investment timing. (Your answer should describe actions to be taken on both stocks and bonds at different points over a typical business cycle.)

b. Assuming Adams’s assertion is correct (that a business expansion is already under way), evaluate the timeliness of his recommendation to purchase Universal Auto, a cyclical stock, based on the business-cycle approach to investment timing.

Universal Auto is a large multinational corporation headquartered in the United States.

For segment reporting purposes, the company is engaged in two businesses: production of motor vehicles and information processing services.

The motor vehicle business is by far the larger of Universal’s two segments. It consists mainly of domestic United States passenger car production, but it also includes small truck manufacturing operations in the United States and passenger car production in other countries. This segment of Universal has had weak operating results for the past several years, including a large loss in 2012. Although the company does not reveal the operating results of its domestic passenger car segments, that part of Universal’s business is generally believed to be primarily responsible for the weak performance of its motor vehicle segment.

Idata, the information processing services segment of Universal, was started by Universal about 15 years ago. This business has shown strong, steady growth that has been entirely internal: No acquisitions have been made.

An excerpt from a research report on Universal prepared by Paul Adams, a CFA candidate, states: “Based on our assumption that Universal will be able to increase prices significantly on U.S. passenger cars in 2013, we project a multibillion-dollar profit improvement . . .”

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