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Question: Case Problem 13.1 Assessing the Stalchecks’s Portfolio Performance LG3 LG4 Mary and Nick Stalchec...

Case Problem 13.1
Assessing the Stalchecks’s Portfolio Performance
LG3 LG4 Mary and Nick Stalcheck have an investment portfolio containing 4 investments. It was developed to provide them with a balance between current income and capital appreciation. Rather than acquire mutual fund shares or diversify within a given class of investments, they developed their portfolio with the idea of diversifying across various asset classes. The portfolio currently contains common stock, industrial bonds, mutual fund shares, and options. They acquired each of these investments during the past 3 years, and they plan to purchase other investments sometime in the future.
Currently, the Stalchecks are interested in measuring the return on their investment and assessing how well they have done relative to the market. They hope that the return earned over the past calendar year is in excess of what they would have earned by investing in a portfolio consisting of the S&P 500 Stock Composite Index. Their research has indicated that the risk-free rate was 7.2% and that the (before-tax) return on the S&P 500 portfolio was 10.1% during the past year. With the aid of a friend, they have been able to estimate the beta of their portfolio, which was 1.20. In their analysis, they have planned to ignore taxes because they feel their earnings have been adequately sheltered. Because they did not make any portfolio transactions during the past year, all of the Stalchecks’s investments have been held more than 12 months, and they would have to consider only unrealized capital gains, if any. To make the necessary calculations, the Stalchecks have gathered the following information on each investment in their portfolio.
Common stock. They own 400 shares of KJ Enterprises common stock. KJ is a diversified manufacturer of metal pipe and is known for its unbroken stream of dividends. Over the past few years, it has entered new markets and, as a result, has offered moderate capital appreciation potential. Its share price has risen from $17.25 at the start of the last calendar year to $18.75 at the end of the year. During the year, quarterly cash dividends of $0.20, $0.20, $0.25, and $0.25 were paid.
Industrial bonds. The Stalchecks own 8 Cal Industries bonds. The bonds have a $1,000 par value, have a 9.250% coupon, and are due in 2024. They are A-rated by Moody’s. The bonds were quoted at 97.000 at the beginning of the year and ended the calendar year at 96.375%.
Mutual fund. The Stalchecks hold 500 shares in the Holt Fund, a balanced, no-load mutual fund. The dividend distributions on the fund during the year consisted of $0.60 in investment income and $0.50 in capital gains. The fund’s NAV at the beginning of the calendar year was $19.45, and it ended the year at $20.02.
Options. The Stalchecks own 100 options contracts on the stock of a company they follow. The value of these contracts totaled $26,000 at the beginning of the calendar year. At year-end the total value of the options contracts was $29,000.
Questions
a.   Calculate the holding period return on a before-tax basis for each of these 4 investments.
b.   Assuming that the Stalchecks’s ordinary income is currently being taxed at a combined (federal and state) tax rate of 38% and that they would pay a 15% capital gains tax on dividends and capital gains for holding periods longer than 12 months, determine the after-tax HPR for each of their 4 investments.
c.   Recognizing that all gains on the Stalchecks’s investments were unrealized, calculate the before-tax portfolio HPR for their 4-investment portfolio during the past calendar year. Evaluate this return relative to its current income and capital gain components.
d.   Use the HPR calculated in question c to compute Jensen’s measure (Jensen’s alpha). Use that measure to analyze the performance of the Stalchecks’s portfolio on a risk-adjusted, market-adjusted basis. Comment on your finding. Is it reasonable to use Jensen’s measure to evaluate a 4-investment portfolio? Why or why not?
e.   On the basis of your analysis in questions a, c, and d, what, if any, recommendations might you offer the Stalchecks relative to the revision of their portfolio? Explain your recommendations

show how to get from a to b.

Sadik Industries must install $1 million of new machinery in its Texas plant. It can obtain a bank loan for 100% of the required amount. Alternatively, a Texas investment banking firm that represents a group of investors believes that it can arrange for a lease financing plan. Assume that these facts apply:

1. The equipment falls in the MACRS 3-year class.
2. Estimated maintenance expenses are $46,000 per year.
3. The firm's tax rate is 31%.
4. If the money is borrowed, the bank loan will be at a rate of 13%, amortized in six equal installments at the end of each year.
5. The tentative lease terms call for payments of $280,000 at the end of each year for 3 years. The lease is a guideline lease.
6. Under the proposed lease terms, the lessee must pay for insurance, property taxes, and maintenance.
7. Sadik must use the equipment if it is to continue in business, so it will almost certainly want to acquire the property at the end of the lease. If it does, then under the lease terms it can purchase the machinery at its fair market value at Year 3. The best estimate of this market value is $160,000, but it could be much higher or lower under certain circumstances. If purchased at Year 3, the used equipment would fall into the MACRS 3-year class. Sadik would actually be able to make the purchase on the last day of the year (i.e., slightly before Year 3), so Sadik would get to take the first depreciation expense at Year 3 (the remaining depreciation expenses would be at Year 4 through Year 6). On the time line, Sadik would show the cost of the used equipment at Year 3 and its depreciation expenses starting at Year 3.

The data has been collected in the Microsoft Excel Online file below. Open the spreadsheet and perform the required analysis to answer the questions below.

Open spreadsheet

To assist management in making the proper lease-versus-buy decision, you are asked to answer the following questions:

1. What is the net advantage of leasing? Should Sadik take the lease? Do not round intermediate calculations. Round your answer to the nearest dollar.

   Net advantage of leasing $  

   Since the cost of leasing the machinery is _________lessgreater than the cost of owning it, the firm should _______leasebuy the equipment.

2. The decision almost can be considered a bet on the future residual value. Do you think the residual cash flows are equal in risk to the other cash flows? (Hint: if you discount a negative cash flow at a higher rate, you get a better NPV — the NPV of a negative cash flow stream is less negative at high discount rates.)

   _____Yes.No.

What is an investment banker and what is their part in Financing the Global Firm?

Over the past six months, Six Flags conducted a marketing study on improving their park experience. The study cost $3.00 million and the results suggested that Six Flags add a kid's only roller coaster.

Suppose that Six Flags decides to build a new roller coaster for the upcoming operating season. The depreciable equipment for the roller coaster will cost $50.00 million and an additional $5.00 million to install. The equipment will be depreciated straight-line over 20 years.

The marketing team at Six Flags expects the coaster to increase attendance at the park by 5%. This translates to 107,097.00 more visitors at an average ticket price of $38.00. Expenses for these visitors are about 17.00% of sales.

There is no impact on working capital. The average visitor spends $22.00 on park merchandise and concessions. The after-tax operating margin on these side effects is 29.00%. The tax rate facing the firm is 34.00%, while the cost of capital is 10.00%.

What is the NPV of this coaster project if Six Flags will evaluate it over a 20-year period? (Six Flags expects the first year project cash flow to grow at 5% per year, going forward)
(Express answer in millions)

Lease versus Buy

Big Sky Mining Company must install $1.5 million of new machinery in its Nevada mine. It can obtain a bank loan for 100% of the purchase price, or it can lease the machinery. Assume that the following facts apply:

1. The machinery falls into the MACRS 3-year class.
2. Under either the lease or the purchase, Big Sky must pay for insurance, property taxes, and maintenance.
3. The firm's tax rate is 35%.
4. The loan would have an interest rate of 15%. It would be nonamortizing, with only interest paid at the end of each year for four years and the principal repaid at Year 4.
5. The lease terms call for $400,000 payments at the end of each of the next 4 years.
6. Big Sky Mining has no use for the machine beyond the expiration of the lease, and the machine has an estimated residual value of $200,000 at the end of the 4th year.

What is the NAL of the lease? Do not round intermediate calculations. Round your answer to the nearest dollar.

$  

Strategic Initiatives and CSR

Get Hitched Inc. is a production company that is in the process of testing a strategic initiative aimed at increasing gross profit. The company’s current sales revenue is $2,100,000. Currently, the company’s gross profit is 35% of sales, but the company’s target gross profit percentage is 40%. The company’s current monthly cost of production is $1,365,000. Of this cost, 60% is for labor, 20% is for materials, and 20% is for overhead.

The strategic initiative being tested at Get Hitched is a redesign of its production process that splits the process into two sequential procedures. The make up of the costs of production for Procedure 1 is currently 50% direct labor, 45% direct materials, and 5% overhead. The makeup of the costs of production for Procedure 2 is currently 50% direct labor, 20% direct materials, and 30% overhead. Company management estimates that Procedure 1 costs twice as much as Procedure 2.

1. Determine what the cost of labor, materials, and overhead for both Procedures 1 and 2 would need to be for the company to meet its target gross profit at the current level of sales.

Cost makeup of Procedure 1:

Cost makeup of Procedure 2:

2. The company’s actual direct materials cost is $390,600 for Procedure 1. Determine the actual cost of direct labor, direct materials, and overhead for each procedure, and the total cost of production for each procedure.

Cost makeup of Procedure 1:

Cost makeup of Procedure 2:

3. The company is planning a CSR initiative to reuse some of the indirect materials used in production during Procedure 2. These indirect materials normally make up 60% of the overhead cost for Procedure 2, but the CSR initiative would reduce the usage of indirect materials. Determine what the maximum new cost of these indirect materials could be for Procedure 2 if this CSR initiative is expected to enable the company to meet its target gross profit percentage (holding all other costs constant).

Maximum new cost of P2 overhead materials:
$

1. Verizon’s free cash flows to the firm are projected to be as follows for the next 5 years (all figures in billions):

How will your confidence in these assumptions change which model you listen to? For instance, if you were 60% confident of your assumptions for each of the P/E, DDM, and DCF models, which one would you rely on? Think about how much a change in your assumptions changes share prices. There isn’t necessarily a mathematically correct answer to this last question. There is, however, an economically reasonable way to justify your thinking regardless of the model you choose to rely on. The internal consistency between what you pick and how you justify it will matter. Would your decision change if you were 60%, 70%, and 80% of the three models, respectively (i.e. less confident of your assumptions for the P/E model relative to the other two)?

You want to buy a $218,000 home. You plan to pay 10% as a down payment, and take out a 30 year loan at 6% interest for the rest.

a) How much is the loan amount going to be?

$

b) What will your monthly payments be?

$

c) How much total interest do you pay?

$

d) Suppose you want to pay off the loan in 15 years rather than 30. What will your monthly payment be?

$

e) How much money in interest will you save if you finance for 15 years instead of 30 years?

A pension fund manager is considering three mutual funds. The first is a stock fund, the second is a long-term government and corporate bond fund, and the third is a T-bill money market fund that yields a sure rate of 4.8%. The probability distributions of the risky funds are:

The correlation between the fund returns is 0.1313.

What is the Sharpe ratio of the best feasible CAL? (Do not round intermediate calculations. Round your answer to 4 decimal places.)

A pension fund manager is considering three mutual funds. The first is a stock fund, the second is a long-term government and corporate bond fund, and the third is a T-bill money market fund that yields a sure rate of 4.8%. The probability distributions of the risky funds are:

The correlation between the fund returns is 0.1313.

What is the Sharpe ratio of the best feasible CAL?

) Dog Up! Franks is looking at a new sausage system with an installed cost of $411,500. This cost will be depreciated straight-line to zero over the project's seven-year life, at the end of which the sausage system is expected to be sold for $35,000 cash. No bonus depreciation will be taken. The sausage system will save the firm $129,400 per year in pretax operating costs, and the system requires an initial investment in net working capital of $22,500. All of the net working capital will be recovered at the end of the project. The tax rate is 23 percent and the discount rate is 13.2 percent. What is the net present value of this project

P.S How to calculate NPV, explanations needed!!!

Pearl Corp. is expected to have an EBIT of $2,200,000 next year. Depreciation, the increase in net working capital, and capital spending are expected to be $160,000, $95,000, and $135,000, respectively. All are expected to grow at 18 percent per year for four years. The company currently has $11,500,000 in debt and 950,000 shares outstanding. After Year 5, the adjusted cash flow from assets is expected to grow at 2.5 percent indefinitely. The company’s WACC is 8.7 percent and the tax rate is 24 percent.

What is the price per share of the company's stock? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

A pension fund manager is considering three mutual funds. The first is a stock fund, the second is a long-term government and corporate bond fund, and the third is a T-bill money market fund that yields a sure rate of 5.0%. The probability distributions of the risky funds are:   

The correlation between the fund returns is .0500.

Suppose now that your portfolio must yield an expected return of 9% and be efficient, that is, on the best feasible CAL.

a. What is the standard deviation of your portfolio? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

b-1. What is the proportion invested in the T-bill fund? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

b-2. What is the proportion invested in each of the two risky funds? (Do not round intermediate calculations. Round your answers to 2 decimal places.)