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Garret Simpson Investments is evaluating a firm (Garp, Inc.) for recommendation to its clients and trying to evaluate the firm's current stock price. The firm is about to offer its shares to the public and had earnings last year of $2.50 a share, which the analysts believe is expected to grow by 20% next year. Similar firms in the industry are currently selling for price-earnings ratios ranging from ten to fifteen times current period earnings. However, these competitor firms are already public entities and have relatively low growth expectations for their earnings. What is your estimate of an appropriate price range for the shares of Garp? Defend your answer.

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Keith LeannonLv2

4 Feb 2019

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a. Parry Electronics is a regional electronics wholesales and distributor that earned $1,250,000 in EBITDA this year based on revenues of $4,000,000. The enterprise values of publicly traded firms that operate in the same industry currently are valued at five to six times their current EBITDA. What is your estimate of the enterprise value of Parry Electronics? If Parry is small relative to the size of the comparison firms, with assets only one-tenth the size of the largest firm in the industry, how would this influence your valuation estimate? Explain.

b. Suppose we have two companies, A and B, that produce identical products using slightly different production processes. THe process used by company A requires more capital equipment, which is already paid for, and can produce the product as lower per-unit costs. Now assume that you have been asked to value company B, which is privately held, and that you want to use company A, which is publicly traded, as the basis for your evaluation. Discuss how differences in the production processees of these firms affect both their multiples and discount rates.

c. In the tech sector, the price of an IPO is often stated as a multiple of its sales, which is then compared to the price/sales ratio of comparable firms. Why do you think that analysts use price/sales ratios in this setting rather than price/earnings ratios?

J.P. Morgan Tells Analysts To Warn of a Downgrade By Wade Lambert and Jathon Sapsford Staff Reporters of The Wall Street Journal March 22, 2001

J.P. Morgan Chase & Co.'s head of European research told his team of analysts they must run all changes in European stock recommendations past both the company in question and J.P. Morgan's investment-banking department. "Both the company and the client banker need to be notified, in advance, of the recommendation change that we plan to make," said the memo, written by Peter Houghton, head of equity research in Europe. "If the company requests changes to the research note, the analyst has a responsibility to either incorporate the changes requested or communicate clearly why the changes cannot be made." The memo, which a company spokesman described as a global policy for the bank and which was previously reported by the Times of London, represents a rare written edict on a practice that raises questions about analysts' independence. Wall Street analysts long have been pressured by corporate clients and their own bankers to shun negative research. Some companies penalize analysts or their firms for "sell" recommendations. Investment bankers pressure analysts because they fear any negative research will hamper their chances of winning lucrative underwriting or advisory business from the same corporate client. Thus, many savvy investors ignore much of the research that comes from securities firms. "It defeats the purpose of research," says Frank Barkocy, director of research at hedge fund Keefe Managers. Mr. Barkocy represents the "buy side," or those who are potential customers for the research of analysts at Wall Street securities firms who are known as the "sell side." By showing the report first to the company in question, "the way an analyst uses some words might very well be minimized," Mr. Barkocy says. "It's a disservice to the analyst and a disservice to the buy side." J.P. Morgan Chase maintains the memo merely reiterates a policy it has long followed, and that it reflects practices that are common in the industry. The company says it sent the memo to ensure that several new analysts who came from other firms know the policy. The company maintains that analysts aren't under pressure to change recommendations, but only to make factual changes. "The point of the memo was to ensure that there's clear communication between analysts and bankers and companies," says Nick O'Donohoe, head of European equities at J.P. Morgan. It is "a normal, common courtesy" to warn a company that an analyst was about to downgrade its stock. Nothing in the memo "compromises the honesty or objectivity or independence of our analysts," he says. Analysts' practices are coming under increased scrutiny after the Securities and Exchange Commission last October began enforcing Regulation FD, for fair disclosure, a rule that seeks to rein in the flow of privileged information between corporations and the Wall Street analysts who cover them. Wall Street analysts also have been criticized for maintaining "buy" recommendations on once-highflying tech stocks, despite their lack of profits, and long after their stocks had fallen. The issue came to a head for many European investors in December over the initial public offering for France Telecom's Orange PLC unit. Analysts were barred from a briefing by Orange officials unless they agreed to let the lead banks "fact-check" their reports on the share offering. Some question whether research can ever be considered objective if the other arm of the firm publishing it is advising the same company on a merger or selling shares. Sebastian Virchow, a fund manager at Deutsche Bank AG's asset-management unit DWS Group in Frankfurt, says his team confirms the earnings and scientific developments of the companies it invests in, rather than taking analysts' reports at face value. "We read the analyst reports and gather information, but we do our own due diligence and would never just use the reports on their own," he says. "We talk to the companies ourselves and make our own earnings estimates." Write to Wade Lambert at [email protected] and Jathon Sapsford at [email protected].

What is meant by "analysts' independence"? When and how might analysts' independence be compromised? What pressures do analysts face that might reduce their independence? Is maintaining a "buy" recommendation on a stock after its price has fallen evidence that an analysts' independence is compromised? Do analysts who currently recommend investing in tech stocks and the broader stock market lack independence?

aquamarinecrow33

Question 5

The coefficient of variation is a better measure of risk than the standard deviation if the expected returns of the securities being compared differ significantly.

True

False

Question 6.

In portfolio analysis, we often use ex post (historical) returns and standard deviations, despite the fact that we are interested in ex ante (future) data.

True

False

Question 7

Typically, debentures have higher interest rates than mortgage bonds primarily because the mortgage bonds are backed by assets while debentures are unsecured.

True

False

Question 8

If two firms have the same current dividend and the same expected growth rate, their stocks must sell at the same current price or else the market will not be in equilibrium.

True

False

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Question 9

Which of the following is the best measure of the wealth of a firm's stockholders?

The firm's Net Income during the past year

Expected Earnings per Share during the coming year

Book Value (or Net Worth) as recorded on the balance sheet

The price of the firm's stock on the open market

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Question 10

Consider the following firms:

	Net Income	Stock Price at	Stock Price at
	this year	Beg of Year	End of Year
Firm A:	$10,000,000	$20	$10
Firm B:	$(10,000,000)	$10	$20

The manager of Firm A is doing a better job than B

The manager of Firm B is doing a better job than A

Neither manager is doing a good job

Both managers are doing a good job

Question 11

A company has the following income statement. What is its net operating profit after taxes (NOPAT)?

Sales $1,000
Costs 700
Depreciation 100
EBIT $ 200
Interest expense 50
EBT $ 150
Taxes (40%) 60
Net income $ 90

Question 12

Carter Corporation has some money to invest, and its treasurer is choosing between City of Chicago municipal bonds and U.S. Treasury bonds. Both have the same maturity, and they are equally risky and liquid. If Treasury bonds yield 6 percent, and Carter's marginal income tax rate is 40 percent, what yield on the Chicago municipal bonds would make Carter's treasurer indifferent between the two?

Question 13

If a firm's current ratio is less than 1.0, it indicates that:

The firm had negative net income for the year

The firm will be unable to pay its shortterm loans which come due this year

Current Assets are less than Current Liabilities

The firm is insolvent

Question 14

A firm which has a relatively large amount of cash and receivables in its current assets accounts and a relatively small amount of current liabilities would be considered:

Question 15

In November 2011 you bought 100 shares of Microsoft stock for $35.375 a share. In November 2013 you sold your stock for $92.5625 a share. What was your average annual rate of return on your Microsoft investment? (disregard dividends and commissions)

Question 16

You deposit $2,000 in a savings account that pays 10 percent interest, compounded annually. How much will your account be worth in 15 years?

Question 17

You can earn 8 percent interest, compounded annually. How much must you deposit today to withdraw $10,000 in 6 years?

Question 18

Calculate the required rate of return for Mercury, Inc., assuming that the real rate of interest is 3 percent, investors expect a 5 percent rate of inflation in the future, and they expect the rate of return on the overall stock market to be 13 percent. Mercury has a beta of 2.0.

Question 19

Which is the best measure of risk for an asset held in isolation? Which is the best measure for an asset held in a diversified portfolio?

Variance; correlation coefficient

Standard deviation; correlation coefficient

Beta; variance

Coefficient of variation; beta

Beta; beta

Question 20

You have three stocks in your portfolio. $10,000 is invested in a stock with a beta of 1.50 and $15,000 is invested in a stock with a beta of 1.00, and $25,000 is invested in a stock with a beta of 0.50. What is the beta of your portfolio?

Question 21

A corporate bond with a $1,000 face value pays a $50 coupon every six months. The bond will mature in ten years, and has a nominal yield to maturity of 9 percent. What is the price of the bond?

Question 22

The Jones Company has decided to undertake a large project. Consequently, there is a need for additional funds. The financial manager plans to issue preferred stock with a perpetual annual dividend of $5 per share and a par value of $30. If the required return on this stock is currently 20 percent, what should be the stock's market value?

Question 23

A share of common stock has just paid a dividend of $2.00. If the expected long-run growth rate for this stock is 15 percent, and if investors require a 19 percent rate of return, what is the price of the stock?

Question 24

A stock is not expected to pay a dividend over the next four years. Five years from now, the company anticipates that it will establish a dividend of $1.00 per share (i.e., D5 = $1.00). Once the dividend is established, the market expects that the dividend will grow at a constant rate of 5 percent per year forever. The risk-free rate is 5 percent, the company's beta is 1.2, and the market risk premium is 5 percent. The required rate of return on the companyâs stock is expected to remain constant. What is the current stock price?