UNIVERSITI TUNKU ABDUL RAHMAN FACULTY OF BUSINESS AND FINANCE UBFF3283 PORTFOLIO MANAGEMENT

TUTORIAL 8

1. Consider the following information about Truly Good Coffee, Inc.

Total assets $240 million Total debt $115 million Preferred stock $25 million Common stockholders' equity $100 million Net profits after taxes $22.5 million Number of preferred stock outstanding 1 million shares Number of common stock outstanding 10 million shares Preferred dividends paid $2/share Common dividends paid $0.75/share Market price of the preferred stock $30.75/share Market price of the common stock $25.00/share

Use the information above to find the following. a. The company's book value. b. Its book value per share. c. The stock's earnings per share (EPS). d. The dividend payout ratio. e. The dividend yield on the common stock. f. The dividend yield on the preferred stock.

2. Describe the general concept of economic analysis. Is this type of analysis necessary, and can it really help the individual investor make a decision about a stock? Explain.

3. What is industry analysis, and why is it important?

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Case Problem I: Wally Wonders Whether Theres a Place for Dividends Wally Wilson is a commercial artist who makes a good living by doing freelance work-mostly layouts and illustrations-for local ad agencies and major institutional clients (such as large department stores). Wally has been investing in the stock market for some time, buying mostly high-quality growth stocks as a way to achieve long-term growth and capital appreciation. He feels that with the limited time he has to devote to his security holdings, high-quality issues are his best bet. He has become a bit perplexed lately with the market, disturbed that some of his growth stocks aren't doing even as well as many good-grade income shares. He therefore decides to have a chat with his broker, Al Fried. During the course of their conversation, it becomes clear that both Al and Wally are thinking along the same lines. Al points out that dividend yields on income shares are indeed way up and that, because of the state of the economy, the outlook for growth stocks is not particularly bright. He suggests that Wally seriously consider putting some of his money into income shares to capture the high dividend yields that are available. After all, as Al says, "the bottom line is not so much where the payoff comes from as how much it amounts to!" They then talk about a high-yield public utility stock, Hydro-Electric Light and Power. Al digs up some forecast information about Hydro-Electric and presents it to Wally for his consideration:

Expected Expected Dividend Year EPS Payout Ratio 2007 $3.25 40% 2008 3.40 40 2009 3.90 45 2010 4.40 45 2011 5.00 45

The stock currently trades at $60 per share. Al thinks that within 5 years it should be trading at around $75 to $80 a share. Wally realizes that to buy the Hydro-Electric stock, he will have to sell his holdings of CapCo Industries - a highly regarded growth stock that Wally is disenchanted with because of recent substandard performance. Questions: a. How would you describe Wally's present investment program? How do you think

it fits him and his investment objectives? b. Consider the Hydro-Electric stock.

1. Determine the amount of annual dividends Hydro-Electric can be expected to pay over the years 2007 to 2011.

2. Compute the total dollar return that Wally will make from Hydro-Electric if he invests $6,000 in the stock and all the dividend and price expectations are realized.

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Case Problem II: Some Financial Ratios Are Real Eye-Openers Jack Arnold is a resident of Lubbock, Texas, where he is a prosperous rancher and businessman. He has also built up a sizable portfolio of common stock, which, he believes, is due to the fact that he thoroughly evaluates each stock he invests in. As Jack says, "Y'all can't be too careful about these things! Anytime I'm fixin to invest in a stock, you can bet I'm gonna learn as much as I can about the company." Jack prefers to compute his own ratios even though he could easily obtain analytical reports from his broker at no cost. (In fact, Billy Bob Smith, his broker, has been volunteering such services for years.) Recently, Jack has been keeping an eye on a small chemical stock. The firm, South Plains Chemical Company, is big in the fertilizer business-which is something Jack knows a lot about. Not long ago, he received a copy of the firm's latest financial statements (summarized here) and decided to take a closer look at the company. South Plains Chemical Company Balance Sheet ($ Thousands) __________________________________________________________________ Cash $ 1,250 Accounts receivable 8,000 Current liabilities $ 10,000 Inventory 12,000 Long-term debt 8,000 Current assets 21,250 Stockholders' equity 12,000 Fixed and other assets 8,750 Total liabilities and Total assets $30,000 stockholders' equity $ 30,000 Income Statement ($ Thousands) _________________________________________________________ Sales $50,000 Cost of goods sold 25,000 Operating expenses 15,000 Operating profit 10,000 Interest expense 2,500 Taxes 2,500 Net profit $ 5,000

Dividends paid to common stockholders ($ in thousands) $1,250 Number of common shares outstanding 5 million Recent market price of the common stock $25

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Questions 1. Compute the following ratios, using the South Plains Chemical Company figures.

Latest Industry Latest Industry Averages Averages

Liquidity Profitability a. Net working capital N/A h. Net profit margin 8.5% b. Current ratio 1.95 i. ROA 22.5% j. ROE 32.2% Activity c. Receivables turnover 5.95 Common Stock Ratios d. Inventory turnover 4.50 k. Earnings per share $2.00 e. Total asset turnover 2.65 l. Price/earnings ratio 20.0 m. Dividends per share $1.00 Leverage n. Dividend yield 2.5% f. Debt-equity ratio 0.45 o. Payout ratio 50.0% g. Times interest earned 6.75 p. Book value per share $6.25 q. Price-to-book-value ratio 6.4 1. Compare the company ratios you prepared to the industry figures given in part a.

What are the company's strengths? What are its weaknesses?

2. What is your overall assessment of South Plains Chemical? Do you think Jack should continue with his evaluation of the stock? Explain.