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# Problem 4.

1 BritMart's Returns
Since its listing last year on the FTSE 100, the market value of BritMart rose
from 21 to 23.5. For each of the following cases calculate the rate of
return, distinguishing the dividend yield from the capital gain:
a) BritMart pays no dividend
b) BritMart decides to pay a dividend of 0.85 per share.
c) BritMart paid the dividend, but the total return to the shareholder is
separated into the dividend yield and the capital gain.
Assumptions
Share price, P1
Share price, P2
Dividend paid, D2

Value
21.00
23.50
0.00

## a. If the company paid no dividend (plugging zero in for the dividend):

Return = ( D2 / P1 ) + ( P2 - P1 ) / P1

11.905%

## b. And if the company paid 0.85 per share:

Assumptions
Share price, P1
Share price, P2
Dividend paid, D2
Total shareholder return, including dividends, is:

Value
21.00
23.50
0.85
15.952%

Return = ( D2 / P1 ) + ( P2 - P1 ) / P1
c. Assuming it did pay the dividend, separate the shareholder's total return
into its two components -- the dividend yield and the capital gain.
Dividend yield is D2 / P1

4.048%

11.905%

15.952%

## Problem 4.2. Romianas Returns (A).

Jennie Smith is a London-based investor. She has been closely following her investment
in 1,000 shares of Romiana, an Italian firm that went public in February 2012. When she
purchased her 1,000 shares at 20 per share, the euro was trading at 0.8375/.
Currently, the share is trading at 25.25 per share, and the exchange rate is 0.722/.

Assumptions
Initial Share Price
Number of shares
Initial exchange rate (/)
Current Share Price
Current Exchange rate (/)

20
1000
0.8375
25.25
0.722

a. If Jennie sells her shares today, what percentage change in the share price would
Change in share price
P2-P1/P1

26.25%

b. What is the percentage change in the value of the euro versus the pound over this same period?
Change in exchage rate
-13.79%
c. What is the total return that Jennie would earn on her shares if she sold them at these rates?
Total return
###
number of shares x (1 + % change in share price)

## Problem 4.3 Romianas Returns (B).

Jennie Smith chooses not to sell her shares at the time described in
Problem 2. She waits, expecting the share price to rise further after the
announcement of quarterly earnings. Her expectations are correct, and
the share price rises to 35 per share after the announcement. She now
wishes to recalculate her returns.

Assumptions
Initial Share Price
Number of shares
Initial exchange rate (/)
Current Share Price
Current Exchange rate (/)

20
1000
0.8375
35.00
0.722

## Change in share price

75.00%
Returns
###
number of shares x (1+%change in share price)

## Problem 4.4 Romianas Returns (C).

If the current spot exchange rate is 0.75/. Using
the same prices and exchange rates as in Problem
3, Romiana (B), what would be the total return on
the Romiana investment in British pounds?
Assumptions
Initial Share Price
Number of shares
Initial exchange rate (/)
Current Share Price
Current Exchange rate (/)
Return in euros
Return in pounds

20
1000
0.8375
35.00
0.75
1,750
###

## Problem 4.5 Building Society's dividend

The following table shows the market share price for a British building society. Since its launch in September 2004, the
management intends to pay a fixed annual dividend of GBP 0.50 per share. How would this constant dividend per year have

Date
Sep-04
Sep-05
Sep-06
Sep-07
Sep-08
Sep-09

Closing
Share
Price
200.00
205.00
216.00
196.00
150.00
193.00

## a. Average shareholder return for the period is

Return = (P2 - P1) / (P1)
b. Total shareholder return if the building society had paid a constant dividend:
Return = (P2 - P1 + D) / (P1)

If
Dividend
Paid

Shareholder
Return
(without Div)

Shareholder
Return
(with Div)

0.50
0.50
0.50
0.50
0.50

2.50%
5.37%
-9.26%
-23.47%
28.67%

2.75%
5.61%
-9.03%
-23.21%
29.00%

0.76%

1.02%

## Problem 4.6 Deutschelanders Rate of Return

Deutschlander Motor Co. issues new stocks and promises to pay an annual
dividend of 1.5. Financial forecasters predict that its market share price
will rise from 100 to 120 after one year. Investors expect German
automobile firms to reap a rate of return of 12%. Supposing that you
intend to hold the stock in your portfolio for one year, should you invest in
this equity?
Assumptions
Share price, P1
Share price, P2
Dividend paid, D2

Value
100.00
120.00
1.50

21.50%

## Return = (P2 - P1 + D2) / (P1)

The share's expected return of 21.50% far exceeds the required return
of 12%. It is therefore a very good investment.

## Problem 4.7 Fashion Acquisitions

The price/earnings ratio (P/E) is one of the tools used to compare companies in the same sector. A high P/E ratio means that investors pay
more for each Swiss franc of net income, especially if they believe that it has future potential. Due to high research and development
expenses incurred by pharmaceutical firms, their P/E is usually higher than those of other industries.
SmallPhar and EuroPhar are hypothetical pharmaceutical firms registered on the Swiss Exchange in Zurich. EuroPhar is considering
acquiring SmallPhar to take advantage of its future growth and potential new drug production. The following table summarizes the financial
situation of both firms:
Market
Total
Number
value
Market
Company
P/E ratio
of shares
per share
Earnings
EPS
Value
SmallPhar
35
2,000,000
CHF 35.00
2,000,000
CHF 1.00
70,000,000
EuroPhar
20
10,000,000
CHF 30.00
15,000,000
CHF 1.50
300,000,000
EuroPhar wants to acquire SmallPhar. It offers 2,500,000 shares of EuroPhar, with a current market value of CHF75,000,000 and a 7.14%
premium on SmallPhars shares, for all of SmallPhars shares.
Rate of exchange -- Modern American shares offered:
2,500,000

a. What is the total number of outstanding shares that EuroPhar will have after acquiring SmallPhar?
10,000,000 + 2,500,000

12,500,000

SmallPhar's shares are worth CHF 35 per share, but Euro Phar also needs to pay a premium for gaining control of Small Phar, so it pays an
b. Calculate the consolidated earnings after the acquisition.
SmallPar earnings + EuroPhar earnings

(CHF)

CHF

17,000,000

c. If the P/E ratio after the capitalization stays at 20, what would be the new market value of EuroPhar?
P/E x Consolidated earnings =

20 x 35000000

CHF

340,000,000

## d. And what would be EuroPhars new EPS?

35,000,000/12,500,000

CHF 1.36

## e. What is the new market value of a share of EuroPhar?

New market value / total shares outstanding = 700,000,000 / 12,500,000

CHF

27.20

CHF

-2.80

## f. How much did EuroPhar's stock price increase?

CHF 56 - CHF 30
Percentage increase

-9.33%

g. Assume that the market takes a negative view of the acquisition and lowers EuroPhar's P/E ratio to 10.
What would be the new market price per share of stock? What would be its percentage loss?
35,000,000 x 10
New market price per share = total market value / shares outstanding =
Percentage loss to original Modern American shareholders = (\$38.71 - \$40.00)/ (\$40.00)

CHF

10

170,000,000
CHF 13.60
-54.67%

## Problem 4.8 Corporate Governance: Overstating Earnings

After the numerous cases of frauds and scandals, a number of firms had to lower their previously reported earnings due to accounting
errors or fraud. Assume that EuroPhar in the previous problem had to lower its earnings to CHF10,000,000 from the previously reported
CHF15,000,000. What might be its new market value prior to the acquisition? Could it still do the acquisition?

Company
Small Phar
Euro Phar

P/E ratio

Number
of shares

Market
value
per share

Earnings

EPS

Total
Market
Value

35
20

2,000,000
10,000,000

CHF 35.00
CHF 30.00

20,000,000
10,000,000

CHF 1.00
CHF 1.50

70,000,000
300,000,000

If earnings were lowered to CHF 10,000,000 could Euro Phar still do the deal?
Small Phar need to be paid their market value plus a premium of 7.14% which is in CHF =

74,998,000

At new market rates for Modern American, this would require the offer of (CHF74,9998,000/CHF30 per share)

2,499,933
shares

## Problem 4.9 Yehti Manufacturing (A)

Dual classes of common stock are common in a number of countries. Assume that Yehti Manufacturing has the following capital
structure at book value. The A-shares each have ten votes and the B-shares each have one vote per share.

Yehti Manufacturing
Long-term debt
Retained earnings
Paid-in common stock: 1 million A-shares
Paid-in common stock: 4 million B-shares
Total long-term capital

Local Currency
(millions)
200
300
100
400
1,000

10.00
1.00

1,000
400
1,400

a. What proportion of the total long-term capital has been raised by A-shares?
A-shares / Total long-term capital

100 / 1,000

10.00%

1,000 / 1,400

71.43%

20.00%

## b. What proportion of voting rights is represented by A-shares?

c. What proportion of the dividends should the A-shares receive?
A-shares in local currency / Total equity shares in local currency

## Problem 4.10 Yehti Manufacturing (B)

Assuming all of the same debt and equity values for Yehti Manufacturing in problem 9, with the sole exception that both Ashares and B-shares have the same voting rights, one vote per share:

Yehti Manufacturing
Long-term debt
Retained earnings
Paid-in common stock: 1 million A-shares
Paid-in common stock: 4 million B-shares
Total long-term capital

Local Currency
(millions)
200
300
100
400
1,000

1.00
1.00

100
400
500

a. What proportion of the total long-term capital has been raised by A-shares?
A-shares / Total long-term capital

100 / 1,000

10.00%

100 / 500

20.00%

20.00%

## b. What proportion of voting rights is represented by A-shares?

c. What proportion of the dividends should the A-shares receive?
A-shares in local currency / Total equity shares in local currency

## Problem 4.11. Softie BabyTex (A).

Softie BabyTex is an Indian-based textile firm that produces all its
financials in Indian rupees (INR). Softie BabyTexs sales director, Simon
Smart, was blamed for declining sales in the United Kingdom. Simon
disagrees, claiming that sales in the United Kingdom have grown
steadily in recent years. Complete the table below to find out whether
Simon is correct.
Assumptions
Total net sales, INR
UK Sales (% of total sales)
Total UK sales, INR
Average exchange rate, INR/
Total UK sales,

2013
2014
2015
###
###
###
50%
45%
44%
1E+006 1E+006 1E+006
100
102
105
10000 10368 10476

## The UK percentage share of total sales shows a consistent decline, but

the absolute value whether in terms of INR or pound is rising. However,
this is not factored for inflation.

## Problem 4.12 Lantau Beer (B): Japanese Yen Debt

Lantau Beer of Hong Kong borrowed Japanese yen under a long-term loan agreement several years ago. The company's
new CFO believes, however, that what was originally thought to have been relatively "cheap debt" is no longer true. What
do you think?
Analysis of Japanese yen-Denominated Debt
Annual yen payments on debt agreement ()
Average exchange rate, /HK\$
Annual yen debt service, HK\$

2008
12,000,000
12.3

2009
12,000,000
12.1

2010
12,000,000
11.4

977,199

994,200

1,057,269

The analysis of debt service payments on the Japanese yen-denominated long-term loan indicates that for the past two
years the effective cost of repaying the loan, in Hong Kong dollars, has been steadily rising as the Hong Kong dollar has
fallen in value against the Japanese yen. In fact, the Japanese yen debt has not proven to be as cheap as thought.

## Mattel's Global Sales

Mattel (US) achieved significant sales growth in its major international regions between 2001 and 2004. In its
filings with the United States Security and Exchange Commission (SEC), it reported what percentage change
in regional sales occurred as a result of exchange rate changes.

## Mattel's Global Sales

(thousands of US\$)
Europe
Latin America
Asia Pacific
Total International
United States
Total Net Sales

2001
Sales (\$)
933,450
471,301
155,791
119,749
1,680,291
3,392,284
(384,651)
4,687,924

Region
Europe
Latin America
Asia Pacific

2002
Sales (\$)
1,126,177
466,349
161,469
136,944
1,890,939
3,422,405
(428,004)
4,885,340

2003
Sales (\$)
1,356,131
462,167
185,831
171,580
2,175,709
3,203,814
(419,423)
4,960,100

2004
Sales (\$)
1,410,525
524,481
197,655
203,575
2,336,236
3,209,862
(443,312)
5,102,786

2001-2002
2002-2003
2003-2004
7.0%
15.0%
8.0%
-9.0%
-6.0%
-2.0%
0.0%
11.0%
5.0%
3.0%
13.0%
6.0%

## Source: Mattel, Annual Report, 2002, 2003, 2004.

a. What was the percentage change in sales, in US dollars, by region?
b. What was the percentage change in sales by region net of currency change impacts?
c. What was the actual US dollar sales levels, by region, net of currency changes?
d. What relative impact did currency changes have on the level and growth of Mattel's consolidated sales for the
2001 to 2004 period?

## Problem 4.13 Mattel's Global Sales Performance

Mattel (U.S.) achieved significant sales growth in its major international regions between 2001 and 2004. In its filings with the
United States Security and Exchange Commission (SEC), it reported what percentage change in regional sales occurred as a
result of exchange rate changes.
(1)
(2)
(3)
Percent
Impact of
Net
2001
2002
Change in
Change in
Change in
(thousands of US\$)
Sales (\$)
Sales (\$)
Gross Sales
Currency Rates
Sales
Europe
\$
933,450
\$
1,126,177
20.6%
7.0%
13.6%
Latin America
471,301
466,349
-1.1%
-9.0%
7.9%
155,791
161,469
3.6%
0.0%
3.6%
Asia Pacific
119,749
136,944
14.4%
3.0%
11.4%
Total International
\$
1,680,291
\$
1,890,939
12.5%
United States
3,392,284
3,422,405
0.9%
(384,651)
(428,004)
11.3%
Total Net Sales
\$
4,687,924
\$
4,885,340
4.2%

(thousands of US\$)
Europe
Latin America
Asia Pacific
Total International
United States
Total Net Sales

(thousands of US\$)
Europe
Latin America
Asia Pacific
Total International
United States
Total Net Sales

2002
Sales (\$)
1,126,177
466,349
161,469
136,944
1,890,939
3,422,405
(428,004)
4,885,340

2003
Sales (\$)
1,356,131
462,167
185,831
171,580
2,175,709
3,203,814
(419,423)
4,960,100

2003
Sales (\$)
1,356,131
462,167
185,831
171,580
2,175,709
3,203,814
(419,423)
4,960,100

(1)
Percent
Change in
Gross Sales
20.4%
-0.9%
15.1%
25.3%
15.1%
-6.4%
-2.0%
1.5%

(2)
Impact of
Change in
Currency Rates
15.0%
-6.0%
11.0%
13.0%

(3)
Net
Change in
Sales
5.4%
5.1%
4.1%
12.3%

2004
Sales (\$)
1,410,525
524,481
197,655
203,575
2,336,236
3,209,862
(443,312)
5,102,786

(1)
Percent
Change in
Gross Sales
4.0%
13.5%
6.4%
18.6%
7.4%
0.2%
5.7%
2.9%

(2)
Impact of
Change in
Currency Rates
8.0%
-2.0%
5.0%
6.0%

(3)
Net
Change in
Sales
-4.0%
15.5%
1.4%
12.6%

Note: The "net change in sales" by global region is determined by netting the change in currency rates from the calcualted
percent change in gross sales. Column (3) = Column (1) + Column (2).
Over the 2001 to 2004 period, Mattel benefited greatly from the change in exchange rates. Only in the case of Latin America,
where exchange rate changes were actually negative in impact on sales levels for the entire period, did the exchange rate changes
not positively impact regional sales.

## Problem 4.14 Chinese Sourcing and the Yuan

Harrison Equipment of Denver, Colorado purchases all of its hydraulic tubing from manufacturers in mainland China.
The company has recently completed a corporate-wide initiative in six sigma/lean manufacturing. Completed oil field
hydraulic system costs were reduced 4% over a one-year period, from \$880,000 to \$844,800. The company is now
worried that all of the hydraulic tubing that goes into the systems (making up 20% of their total costs) will be hit by the
potential revaluation of the Chinese yuan -- if some in Washington get their way. How would a 12% revaluation of the
yuan against the dollar impact total system costs?
Assumptions
Total system cost (\$)
Cost savings from six sigma/lean
Total system cost (\$)
Hydraulic tubing, % of total
Hydraulic tubing (\$)

Original/Current
\$880,000.00
4.0%
\$844,800.00
20.0%
\$168,960.00

Revaluation?

Future?

\$189,235.20

## A 12% revaluation of the yuan would be calculated: Yuan 8.28 / (1 + % change)

Exchange rate (yuan/\$)
Hydraulic tubing (yuan)

8.28
1,398,988.80

## Cost increase as a result of revaluation

Total system cost after revaluation

12.0%

7.39
1,398,988.80
\$20,275.20
\$865,075.20

a. The revaluation of the Chinese yuan by 12% would completely nullify all of the cost reduction benefits achieved via
the six sigma/lean manufacturing initiatives recently completed.
b. The percentage change in the cost of the total hydraulic system can be calculated by multiplying the percentage
increase in the exchange rate times the percent of total cost made up by the hydraulic tubing:
Hydraulic tubing, % of total
Percent revaluation of the yuan
Total system cost impact, percent
New total system cost (\$)
Old total system cost (\$)
Percent change

20.0%
12.0%
2.40%
\$865,075.20
\$844,800.00
2.40%

## Problem 4.15 S&P 500 Equity Returns: 1930-2010

The U.S. equity markets have delivered very different returns over the past 90 years. Use the following data arranged by decade to answer the following questions
about these U.S. equity investment returns.
a.
b.
c.
d.

Which period shown had the highest total returns? The lowest?
Which decade had the highest dividend returns? When were dividends clearly not a priority for publicly traded companies?
The 1990s was a boom period for U.S. equity returns. How did firm's react in terms of their dividend distributions?
How has the 2000s period fared? How do you think publicly traded companies have started changing their dividend distribution habits as a result?

## S&P 500 Equity Returns, 1926-2014 (average annual return, percent)

Period
Capital appreciation
Dividend yield
Total return

1930s
-5.3%
5.4%
0.1%

1940s
3.0%
6.0%
9.0%

1950s
13.6%
5.1%
18.7%

1960s
4.4%
3.3%
7.7%

1970s
1.6%
4.2%
5.8%

1980s
12.6%
4.4%
17.0%

1990s
15.3%
2.5%
17.8%

2000s
-2.7%
1.8%
-0.9%

1926 to
2014
5.9%
4.0%
9.9%

a. Which period shown had the highest total returns? The lowest?
The 1950s -- somewhat surprisingly -- had the highest total returns. The lowest were the 2000s.
b. Which decade had the highest dividend returns? When were dividends clearly not a priority for publicly traded companies?
Dividend returns were the highest in the 1940s. Since 2000 dividend yields have clearly been a lower priority.
c. The 1990s was a boom period for U.S. equity returns. How did firm's react in terms of their dividend distributions?
Dividend distributions/yields were clearly down during this era.
d. How has the 2000s period fared? How do you think publicly traded companies have started changing their dividend distribution habits as a result?
A negative return for 2000s shows pretty awful performance! Companies are increasing dividends -- now --- finally -- as a result.

## S&P 500 Equity Returns, 1926-2014 (average annual return, percent)

Period
Capital appreciation
Dividend yield
Total return

1930s
-5.3%
5.4%
0.1%

1940s
3.0%
6.0%
9.0%

1950s
13.6%
5.1%
18.7%

1960s
4.4%
3.3%
7.7%

Source: Data drawn from "JP Morgan Guide to the Markets, 2015," JP Morgan Asset Management.

1970s
1.6%
4.2%
5.8%

1980s
12.6%
4.4%
17.0%

1990s
15.3%
2.5%
17.8%

2000s
-2.7%
1.8%
-0.9%

1926 to
2014
5.9%
4.0%
9.9%