Financial Reporting, Financial Statement Analysis and Valuation
8th Edition
ISBN: 9781285190907
Author: James M. Wahlen, Stephen P. Baginski, Mark Bradshaw
Publisher: Cengage Learning
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Chapter 11, Problem 10PC
The data in Exhibit 11.3 on industry median betas suggest that firms in the following three sets of related industries have different degrees of systematic risk.
REQUIRED
- a. For each matched pair of industries, describe factors that characterize a typical firm’s business model in each industry. Describe how such factors would contribute to differences in systematic risk.
- b. For each matched pair of industries, use the
CAPM to compute the required rate ofreturn on equity capital for the median firm in each industry. Assume that the risk-free rate of return is 4.0% and the market risk premium is 5.0%. - c. For each matched pair of industries, compute the
present value of a stream of $1 dividends for the median firm in each industry. Use the perpetuity-with-growth model and assume 3.0% long-run growth for each industry. What effect does the difference in systematic risk across industries have on the per-dollar dividend valuation of the median firm in each industry?
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Analyst forecasts which focus on a top-down approach to forecasting future performance are most likely paying attention to:
A. Macroeconomic factors such as gross domestic product (GDP)
B. Signals from individual companies within an industry first
OC. Microeconomic factors such as dividend yields on bio-technology stocks (shares)
Firms use several techniques to estimate risk, see Chapter 8. After describing these techniques, explain how firms incorporate risk in the investment evaluation process. Give examples of alternative ways a firm can use to estimate the cost of equity, and by extension the Weighted-Average Cost of Capital (WACC or Kw). Be specific as to the reasons firms use multiple hurdle rates when considering different investment projects.
Using the data in the following table for a number of firms in the same industry, dothe following:•a. Compute the total asset turnover, the net profit margin, the equity multiplier, andthe return on equity for each firm.b. Evaluate each firm’s performance by comparing the firms with one another.Which firm or firms appear to be having problems? What corrective actionwould you suggest the poorer performing firms take? Finally, what additional data would you want to have on hand when conducting youranalyses?Firm
(in million Dollars
A
B
C
D
Sales
$20
$10
$15
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Net Income after sales
3
0.5
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3
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Chapter 11 Solutions
Financial Reporting, Financial Statement Analysis and Valuation
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