Security Analysis Problems
Each solution should include a statement of the problem and the accompanying answer. Paraphrase all responses and avoid simply restating what is written in the textbook. For numeric solutions, provide full documentation of the process used to reach the solution. For problems that require additional analyses.
Part 1
CPA Examination Level II. As a security analyst, you have been ask to review a valuation of a closely held business - Wigwam Autoparts Heaven, Inc. (WAH), prepared by the Red Rocks Group (RRG). You are to give an opinion on the valuation and to support your opinion by analyzing each part of the valuation. WAH's sole business is automotive parts retailing.
RRG valuation includes a section called, "Analysis of the Retail Autoparts Industry," based completely on the data in table 1 and the following information.
• WAH and its principle competitors each operated over 150 stores at year end 1994.
• The average number of stores operated per company engaged in the retail autoparts industry is 5.3.
• The major consumer base for autoparts sold in retail stores consist of young owners of old vehicles. These owners do their own automotive maintenance out of economic necessaity.
a. One RRG's conclusions is that the retail autoparts industry as a whole is in the stabilization stage of the industry life cycle. Discuss three relative items of data from table 1 that supports this conclusion.
b. Another RRG conclusion is that WAH and its principal competitors are in the growth stage of their life cycle. Cite three relevant items from table 1 that supports this conclusion. Explain how WAH and its principal competitors can be in a growth stage while their industry as a whole is in the stabilization stage.
| |
1994 |
1993 |
1992 |
1991 |
1990 |
1989 |
1988 |
1987 |
1986 |
1985 |
| Population 18-29 year old (percentage Change) |
-1.80% |
-2.00% |
-2.10% |
-1.40% |
-0.80% |
-0.90% |
-1.10% |
-0.90% |
-0.70% |
-0.30% |
| Number of households with income more than $35,000 (percentage change) |
6.00% |
4.00% |
8.00% |
4.50% |
2.70% |
3.10% |
1.60% |
3.60% |
4.20% |
2.20% |
| Number of households with income less than $35,000 (percentage change) |
3.00% |
-1.00% |
4.90% |
2.30% |
-1.40% |
2.50% |
1.40% |
-1.30% |
0.60% |
0.10% |
| Number of cars 5-15 years old (percentage change) |
0.90% |
-1.30% |
-6.00% |
1.90% |
3.30% |
2.40% |
-2.30% |
-2.20% |
-8.00% |
1.60% |
| Automotive aftermarket industry retail sales (percentage change) |
5.70% |
1.90% |
3.10% |
3.70% |
4.30% |
2.60% |
1.30% |
0,2% |
3.70% |
2.40% |
| Consumer expenditures on automotive parts and accessories (percentage change) |
2.40% |
1.80% |
2.10% |
6.50% |
3.60% |
9.20% |
1.30% |
6.20% |
6.70% |
6.50% |
| Sales growth of retail auto parts companies with 100 or more stores. |
17.00% |
16.00% |
16.50% |
14.00% |
15.50% |
16.80% |
12.00% |
15.70% |
19.00% |
16.00% |
| Market share of retail auto parts companies with 100 or more stores. |
19.00% |
18.50% |
18.30% |
18.10% |
17.00% |
17.20% |
17.00% |
16.90% |
15.00% |
14.00% |
| Average operating margin of retail auto parts companies with 100 or more stores. |
12,0% |
11.80% |
11.20% |
11.50% |
10.60% |
10.60% |
10.00% |
10.40% |
9.80% |
9.00% |
| Average operating margin of all retail auto parts companies |
5.50% |
5.70% |
5.60% |
5.80% |
6.00% |
6.50% |
7.00% |
7.20% |
7.10% |
7.20% |
Part 2
3). Given Cara's beta of 1.75 and a risk-free rate of 7%, what is the expected rate of return for Cara assuming
a. a 15 percent market return?
b. a 10 percent market return?
CPA examination Level, 1. Your client is considering the purchase of $100,000 in common stock, which pays no dividends and will appreciate in market value by 10 percent per year. At the same time, the client is considering an opportunity to invest $100,000 in a lease obligation that will provide the annual year-end cash listed below. Assume that each investment will be sold at the end of three years and that you are given no additional information.
Calculate the present value of each of the two investments assuming a 10 percent discount rate, and state which one will provide the higher return over the three year period. Show you calculations.
End of Year
1............................................................. $ -0-
2 Lease Receipts............................................. 15,000
3 Lease Receipts......................................................25,000
4 Sale Proceeds................................................100,000
Present Value of $1
Period 6% 8% 10% 12%
1..............................0.943...............0.926..............0.909..................0.893
2..............................0.890...............0.857..............0.826..................0.797
3..............................0.840...............0.794..............0.751..................0.712
4..............................0.792...............0.735..............0.683..................0.636
5..............................0.747...............0.681..............0.621..................0.567
Part 3
You are currently managing z a stock portfolio worth $55 million and you are concerned that, over the next four months, equity values will be flat and may even fall. Consequently, you are considering two different strategies for hedging against possible stock declines: (1) buying a protective put, and (2) selling a covered call (i.e., selling a call option based on the same underlying stock position you hold). An over-the-counter derivatives dealer has expressed interest in your business and has quoted the following bid and offer prices (in millions) for at-the-money call and put options that expire in four months and match the characteristics of your portfolio.
Bid Ask
Call $2.553 $2.573
Put 1.297 1.317
a. For each of the following expiration date values for the unhedged equity position, calculate the terminal values (net of initial expense) for a protective put strategy.
35, 40, 45, 50, 55, 60, 65, 70, 75
c. For each of these same expiration date stock values, calculate the terminal net profit values for a covered call strategy.