Group Assignment 2

Investment Analysis and Portfolio Management

AcFn 612
Max marks 20%
Submission Date: Up-to 3rd July 2020 (Friday)
Submitted by email: azimeadem@gmail.com
Note: Please get confirmation after you submitted the assignment.
1. Would you expect the risk premium for an investment in an Ethiopia stock to be the same
as that for a stock from the Kenya? Discuss your reasoning.

2. Under what conditions will it be ideal to use one or several of the relative valuation ratios
to evaluate a stock?

3. Discuss a scenario where it would be appropriate to use one of the present value of cash
flow techniques for the valuation.
4. Discuss why the two valuation approaches (present value of cash flows and the relative
valuation ratios) are competitive or complementary.

Problems:

1. What is the value to you of a 9 percent coupon bond with a par value of $10,000 that
matures in 10 years if you want a 7 percent return? Use semiannual compounding.
2. What would be the value of the bond in Problem 1 if you wanted an 11 percent rate of
return?
3. The preferred stock of the Clarence Radiology Company has a par value of $100 and a $9
dividend rate. You require an 11 percent rate of return on this stock. What is the
maximum price you would pay for it? Would you buy it at a market price of $96?
4. The Baron Basketball Company (BBC) earned $10 a share last year and paid a dividend
of $6 a share. Next year, you expect BBC to earn $11 and continue its payout ratio.
Assume that you expect to sell the stock for $132 a year from now. If you require 12
percent on this stock, how much would you be willing to pay for it?

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5. Given the expected earnings and dividend payments in Problem 4, if you expected a
selling price of $110 and required an 8 percent return on this investment, how much
would you pay for the BBC stock?
6. Over the long run, you expect dividends for BBC in Problem 4 to grow at 8 percent and
you require 11 percent on the stock. Using the infinite period DDM, how much would you
pay for this stock?

7. Based on new information regarding the popularity of basketball, you revise your growth
estimate for BBC to 9 percent. What is the maximum P/E ratio you will apply to BBC,
and what is the maximum price you will pay for the stock?
8. The Shamrock Dogfood Company (SDC) has consistently paid out 40 percent of its
earnings in dividends. The company’s return on equity is 16 percent. What would you
estimate as its dividend growth rate?
9. Given the low risk in dog food, your required rate of return on SDC is 13 percent. What
P/E ratio would you apply to the firm’s earnings?
10. What P/E ratio would you apply if you learned that SDC had decided to increase its
payout to 50 percent? (Hint: This change in payout has multiple effects.)
11. Discuss three ways a firm can increase its ROE. Make up an example to illustrate your
discussion.
12. It is widely known that grocery chains have low profit margins—on average they earn
about 1 percent on sales. How would you explain the fact that their ROE is about 12
percent? Does this seem logical?

13. Compute a recent five-year average of the following ratios for three companies of your
choice (attempt to select diverse firms):
a. Retention rate
b. Net profit margin
c. Equity turnover
d. Total asset turnover
e. Total assets/equity

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 Based on these ratios, explain which firm should have the highest growth rate of
earnings.
14. You have been reading about the Maddy Computer Company (MCC), which currently
retains 90 percent of its earnings ($5 a share this year). It earns an ROE of almost 30
percent. Assuming a required rate of return of 14 percent, how much would you pay for
MCC on the basis of the earnings multiplier model? Discuss your answer. What would
you pay for Maddy Computer if its retention rate was 60 percent and its ROE was 19
percent? Show your work.
15. Gentry Can Company’s (GCC) latest annual dividend of $1.25 a share was paid yesterday
and maintained its historic 7 percent annual rate of growth. You plan to purchase the
stock today because you believe that the dividend growth rate will increase to 8 percent
for the next three years and the selling price of the stock will be $40 per share at the end
of that time.
a. How much should you be willing to pay for the GCC stock if you require a 12
percent return?
b. What is the maximum price you should be willing to pay for the GCC stock if
you believe that the 8 percent growth rate can be maintained indefinitely and you
require a 12 percent return?
c. If the 8 percent rate of growth is achieved, what will the price be at the end of
Year 3, assuming the conditions in Part b?