Possible Risks in Management - Assignment Example

Question b. provides a way to consider the risk of the returns being offered Question 2 d. Agency problems Explanation: The managers are agents to the owners and when there is a conflict between the objectives of the agent and the principal, which are the owners. Question 3 d. increase, decline Explanation: The increase in debt ratio increases the perceived risk of holding the company’s bonds. In order to compensate for this risk, the required rate of return increases too. As the return increases, the value of the bond declines. Question 4 b. weak-form efficiency Question 5 a. 2.08% Explanation: Vcs= (D1/1+kcs) + (P1/1+kcs) 48= (4/1+kcs) + (45/1+kcs) 48kcs=49-48 Kcs=1/48 or .020833 Question 6 c. risk Explanation: The firm’s financial leverage will only benefit up to some extent. When the firm borrows too much, the investors are faced with concerns as regards the firm’s ability to sustain the operation on its own as well as issues of liquidity. This makes the firm riskier from the eyes of the investors. Question 7 a. paying off some current liabilities with cash Explanation: By reducing the current liabilities by paying off cash, both current liabilities and assets are reduced by the amount. Therefore, because the current assets are twice the amount of the current liabilities, decreasing both sides by the same amount will increase the current ratio, making it greater than 2:1. Question 8 c. the firm sells off some unused assets and pays the proceeds to existing stockholders in the form of an extra dividend Explanation: Return on total assets is comprised of net income as the numerator, and total assets as the denominator. Increase in ROA signifies on two possible explanations: an increase in net income, or a decrease in total assets. Hence, choice C will decrease the total assets and affect ROA. Question 9 b. customers are not paying their bills on time Explanation: Average collection period is measured by dividing accounts receivable by the daily credit sales figure. An increase in the average collection period will signify two possibilities: either the accounts receivable as the numerator is increased, or the daily credit sales figure is decreased. Hence, the increase in collection period may not suggest whether customers are not paying their bills on time or not, as the formula does not tell when is ‘on-time’ as it is dependent on the firm’s policy. Question 10 c. purchase additional inventory on credit Explanation: Current ratio is determined by dividing the current assets figure by the current liabilities. In order to increase the current ratio, either the current assets should be increased, or the current liabilities are decreased. Among the choices, purchasing additional inventory on credit will increase the current ratio. As both current assets and liabilities increase by the same figure, the proportion increases. Question 11 b. 6240 Explanation: If current ratio=2.5 And current assets=12000; hence, current liabilities is 12000/2.5 or 4800 If quick ratio=1.2 And current liabilities is 4800; hence, quick assets is 4800*1.2 or 5760 If inventory=current assets-quick assets Hence, inventory=12000-5760, or 6240. Question 12 a. 10 million Question 13 c. greater the effective interest rate Explanation: “As interest is compounded at shorter and shorter intervals, less time passes before interest can be earned on interest. Therefore, the effective annually compounded rate of interest increases (Brealey, Myers & Marcus 2004, p.101).” Question 14 d. 1,469 Question 15 b. about 40% Question 16 a. 43, 785 Payment at the beginning: Payment at the end of period Difference Question 17 c. 7% Question 18 d. 6081.25 Question 19 d. the higher the correlation of returns between the two stocks, the higher the portfolio’s risk Explanation: The formula for computing the portfolio risk or standard deviation is: σp=sqrt (wa2σa2 + wb2σb2 + 2 wa wbρabσa σb where ρab = correlation between returns of a & b; the higher the correlation, the higher risk to the whole portfolio Question 20 b. foreign competition with an industry’s products Explanation: Systematic risk is associated with the stock market risk in general. Therefore, foreign competition with an industry’s products poses a risk on the industry and the company, but not the stock market as a whole. Hence, choice b is the answer. Question 21 d. the security has below-average systematic risk Explanation: A beta of 1 means the company is as risky as the average stock market risk, therefore 0.5 means that the company’s risk is lower than the entire market. Question 22 b. shift down and have the same slope Explanation: Changes in inflation poses a systematic risk, so there is no change in the slope but there is a parallel shift to it. Because investors become risk-averse overall, the SML shifts down. Question 23 b. for a given return, there is no other portfolio with a lower standard deviation Explanation: Standard deviation is a measure of risk. For a given return, if there is no other portfolio that could have higher volatility, then the portfolio is efficient. Question 24 a. 8% Question 25 a. 1.00 Explanation: Standard deviation = sqrt (expected return-mean)2 * probability Hence, substituting x for probability and computing algebraically .0049 = 0.0049x, where x=1 Question 26 a. 12.42% Question 27 d. 25.04 Explanation: P0=DIV1/(r-g) First, get r: R= rf + β (rm – rf) R= 9.2% + 1.2 (6%) R= 16.4% Second, get DIV1 DIV1=DIV0 (1+g)t DIV1=2.20 (1+7%)1 DIV1=2.354 Lastly, get P0 P0=2.354/(16.4%-7%) P0=25.04255 Question 28 b. Yes, stock price increases $15.27 Explanation: P0=DIV1/(r-g) First, get r: Second, get DIV1 Lastly, get P0 Question 29 b. 1.07 Question 30 c. a rate greater than 8% Explanation: Mortgage bonds are bonds secured by a lien on real property; a debenture is an unsecured debt. Therefore, debentures are riskier than the mortgage bonds. In order to convince investors to purchase an identical bond but a debenture, the returns should be higher to incorporate the additional risks. Question 31 a. more Question 32 b. if interest rates decline Explanation: If interest rates decline, bond prices will rise. Because of the option to call, the issuer can repurchase the bond at a fixed call price—a price which puts a ceiling on the bond price. Question 33 d. cannot be determined Explanation: YTM will be higher than coupon if the bond price is less than the face value; YTM will be lower than the coupon if the bond price is greater than the face value. Since the bond price is given but the face value is not, there is no benchmark so it cannot be determined. Question 34 b. 4.64% Question 35 c. 896 Question 36 b. 11.5% Note: no final payment is given, hard to compute yield-to-maturity with one given missing Question 37 c. retained earnings account Explanation: When stock dividends are issued, the amount is transferred from the company’s retained earnings account and transferred to common stocks in lieu of cash. Question 38 b. higher, decline Explanation: When the general level of interest rates in the economy moves up, the cost of capital in the economy generally becomes higher. Thus, the rate of return will be higher. When the rate of return is higher, there are less projects that could surpass it in terms of expected return, hence the stock prices decline. Question 39 b. to increase retained earnings Explanation: Stock repurchase will require company to put the value in the treasury stock account, not in the retained earnings account. Question 40 c. $25.68 Explanation: P0=DIV1/(r-g) First, get DIV1 Then, get P0 Text Problem #1 First, get the annuity payments for each year Next, get the total annual required payments Then, get the earnings of the investments each year. The assumption is, the interest is subtracted each year to contribute to the payment of annuities. Therefore, only the principal, 8000 will grow at 7% return each year, interest not included. Lastly, deduct the investment earnings from the total annuity payments, The differences are the required figures to save each year (beginning of the year) in order to accomplish goals for Charlie. In year 6, year before Charlie gets his 25 000, the required annuity is only 2699.84. By then, the 8,000 in investments have already earned 4005.84281. This means a gain by 1306.00281 for the investor at year 6. Text Problem #2 Explanation: First, get the annual dividends and the price based on the given growth rate and given rate of return: Next, get the stock price at year 6 by dividing the dividend in year 7 by the difference between the required rate of return (16%) and growth rate (10%): Then, discount the cash flows up to year 6 by 16% to get the present value: Add the total PV of the dividends and the PV of price at year 6 Mylanta’s stock value is 8.119328 at year 0. Note: The formula for the non-constant growth model requires computing first the PV of dividends from years 1 to 6 and adding the PV of forecast stock price in year 6. Since the price is not given, the formula for computing the market price is substituted. However, the formula to get the price is dividend in year 1/(expected rate of return - growth rate). Since the expected rate of return is not given, only the required rate of return, theoretically what we have computed in year 6 is Mylanta’s intrinsic value. This figure is the substitute for market price to get the PV in year 0. Read More