Question: Dara's Dilemma: What to Buy?
Dara Simmons, a 40-year-old financial analyst and divorced mother of two teenage children, considers herself a savvy investor. She has increased her investment portfolio considerably over the past five years. Although she has been fairly conservative with her investments, she now feels more confident in her investment knowledge and would like to branch out into some new areas that could bring higher returns. She has between $20,000 and $25,000 to invest. Attracted to the hot market for technology stocks, Dara was interested in purchasing a tech IPO stock and identified NewestHighTech.com, a company that makes sophisticated computer chips for wireless Internet connections, as a likely prospect. The 1-year-old company had received some favorable press when it got early-stage financing and again when its chip was accepted by a major cell phone manufacturer.
Dara also was considering an investment in 400 shares of Casinos International common stock, currently selling for $54 per share. After a discussion with a friend who is an economist with a major commercial bank, Dara believes that the long-running bull market is due to cool off and that economic activity will slow down. With the aid of her stockbroker, Dara researches Casinos International's current financial situation and finds that the future success of the company may hinge on the outcome of pending court proceedings on the firm's application to open a new floating casino on a nearby river. If the permit is granted, it seems likely that the firm's stock will experience a rapid increase in value, regardless of economic conditions. On the other hand, if the company fails to get the permit, the falling stock price will make it a good candidate for a short sale. Dara felt that the following alternatives were open to her:
Alternative 1: Invest $20,000 in NewestHighTech.com when it goes public.
Alternative 2: Buy Casinos International now at $54 per share and follow the company closely.
Alternative 3: Sell Casinos short at $54 in anticipation that the company's fortunes will change for the worse.
Alternative 4: Wait to see what happens with the casino permit and then decide whether to buy or short sell the Casinos International stock.
a. Evaluate each of these alternatives. On the basis of the limited information presented, recommend the one you feel is best.
b. If Casinos International's stock price rises to $60, what will happen under alternatives 2 and 3? Evaluate the pros and cons of these outcomes.
c. If the stock price drops to $45, what will happen under alternatives 2 and 3? Evaluate the pros and cons of these outcomes.