EBK CORPORATE FINANCE
11th Edition
ISBN: 8220102798878
Author: Ross
Publisher: YUZU
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Textbook Question
Chapter 14, Problem 21CQ
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Analysts and investors often use return on equity (ROE) to compare profitability of a company with other firms in the industry. ROE is considered a very important measure, and managers strive to make the company’s ROE numbers look good.
A) If a firm takes steps that increase its expected future ROE, its stock price will increase.
B) Based on your understanding of the uses and limitations of ROE, which of the following projects will a manager likely choose if his or her bonus is solely based on the ROE of the next project?
Project Y, with 40% ROE and a small investment, generating low expected cash flows
Project X, with 35% ROE and a large investment, generating high expected cash flows
C) Suppose you are trying to decide whether to invest in a company that generates a high expected ROE, and you want to conduct further analysis on the company’s performance. If you wanted to conduct a comparative analysis for the current year, you would:
Compare the…
GohwaT has a client who has inquired about the valuation method best suited for comparison of companies in an industry that has the following characteristics:• Principal competitors within the industry are located in the United States, France, Japan, and Brazil.• The industry is currently operating at a cyclical low, with many firms reporting losses.• The industry is subjected to rapid technological change.His advisor recommends that the client consider the following valuation ratios:1. Price to earnings2. Price to book value3. Price to salesDetermine which one of the three valuation ratios is most appropriate for comparing companies in this industry. Support your answer with two reasons that make that ratio superior to either of the other two ratios.
Discussion Question on Market Efficiency
Consider the following statements from two different investors regarding their
strategies for investment. Assuming the stock market is efficient, which investor has
the best strategy? Be sure to fully explain your answer.
Investor 1
My strategy is to find companies that are
undervalued. Because they are undervalued, I representing the overall stock market. I do not
expect these companies to experience a lot of
growth. And I have been pretty successful at
it. About 50% of the time, I am correct in
choosing undervalued stock.
Investor 2
My strategy is to invest in mutual fund
believe I know that much more than all other
investors, so the stock price we see in the
market is probably a good indicator of the
fundamental value of the stock. So there is no
use in trying to find undervalued or
overvalued stocks
Chapter 14 Solutions
EBK CORPORATE FINANCE
Ch. 14 - Prob. 1CQCh. 14 - Prob. 2CQCh. 14 - Efficient Market Hypothesis Which of the following...Ch. 14 - Market Efficiency Implications Explain why a...Ch. 14 - Efficient Market Hypothesis A stock market analyst...Ch. 14 - Semistrong Efficiency If a market is semistrong...Ch. 14 - Efficient Market Hypothesis What are the...Ch. 14 - Prob. 8CQCh. 14 - Prob. 9CQCh. 14 - Efficient Market Hypothesis For each of the...
Ch. 14 - Technical Analysis What would a technical analyst...Ch. 14 - Prob. 12CQCh. 14 - Prob. 13CQCh. 14 - Efficient Markets A hundred years ago or so,...Ch. 14 - Efficient Market Hypothesis Aerotech, an aerospace...Ch. 14 - Prob. 16CQCh. 14 - Prob. 17CQCh. 14 - Efficient Market Hypothesis Newtech Corp. is going...Ch. 14 - Prob. 19CQCh. 14 - Efficient Market Hypothesis The Durkin Investing...Ch. 14 - Efficient Market Hypothesis Your broker commented...Ch. 14 - Efficient Market Hypothesis A famous economist...Ch. 14 - Efficient Market Hypothesis Suppose the market is...Ch. 14 - Prob. 24CQCh. 14 - Prob. 25CQCh. 14 - Efficient Market Hypothesis Assume that markets...Ch. 14 - Prob. 27CQCh. 14 - Evidence on Market Efficiency Some people argue...Ch. 14 - Prob. 1QPCh. 14 - Cumulative Abnormal Returns The following diagram...Ch. 14 - Cumulative Abnormal Returns The following figures...Ch. 14 - Prob. 4QPCh. 14 - Prob. 1MCCh. 14 - Prob. 2MCCh. 14 - Prob. 3MC
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- If the firm is in a very competitive, mature industry, what effect will the competitive conditions have on residual income for the firm and others in the industry? Now suppose the firm holds a competitive advantage in its industry, but the advantage is not likely to be sustainable for more than a few years. As the firm’s competitive advantage diminishes, what effect will that have on that firm’s residual income? and If a firm’s residual income for a particular year is positive, does that mean the firm was profitable? Explain. If a firm’s residual income for a particular year is negative, does that mean the firm necessarily reported a loss on the income statement? Explain. What does it mean when a firm’s residual income is zero?arrow_forwardAnalysts and investors often use return on equity (ROE) to compare profitability of a company with other firms in the industry. ROE is considered a very important measure, and managers strive to make the company’s ROE numbers look good. If a firm takes steps that increase its expected future ROE, its stock price will increase. Based on your understanding of the uses and limitations of ROE, a rational investor is likely to prefer an investment option that has: High ROE and high risk High ROE and low riskarrow_forwardUsing 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 $25 Net Income after sales 3 0.5 2.25 3 Total Assets 15 7.5 15 24 Stockholders’ Equity 10 5 14 10arrow_forward
- 7. More on ratio analysis Analysts and investors often use return on equity (ROE) to compare profitability of a company with other firms in the industry. ROE is considered a very important measure, and managers strive to make the company's ROE numbers look good. If a firm takes steps that increase its expected future ROE, its stock price will increase. Based on your understanding of the uses and limitations of ROE, which of the following projects will a manager likely choose if his or her bonus is solely based on the ROE of the next project? O Project Y, with 40% ROE and a small investment, generating low expected cash flows O Project X, with 35% ROE and a large investment, generating high expected cash flows Suppose you are trying to decide whether to invest in a company that generates a high expected ROE, and you want to conduct further analysis on the company's performance. If you wanted to conduct a trend analysis, you would: O Analyze the firm's financial ratios over time Compare…arrow_forward13) What did Jim Brown at DuPont use to compare the efficiency of vastly different projects? Select an answer: operating efficiency return on investment sales profitability return on equity 14) Why would competitors want to see another company's financial statements? Select an answer: to help determine the strengths and weaknesses of the company's finances to determine whether the company is eligible for a loan to decide whether or not to make an investment in the company's stock to provide background information on a competitor's market 15) What is the primary asset of any bank? Select an answer: checking and savings accounts investments accounts receivable real estatearrow_forwardAnalysts and investors often use return on equity (ROE) to compare profitability of a company with other firms in the industry. ROE is considered a very important measure, and managers strive to make the company's ROE numbers look good. If a firm takes steps that increase its expected future ROE, its stock price will Based on your understanding of the uses and limitations of ROE, a rational investor is likely to prefer an investment option that has: O High ROE and high risk O High ROE and low risk increase. Suppose you are trying to decide whether to invest in a company that generates a high expected ROE, and you want to conduct further analysis on the company's performance. If you wanted to conduct a comparative analysis for the current year, you would: O Compare the firm's financial ratios with other firms in the industry for the current year Compare the firm's financial ratios for the current year with its ratios in previous years You decide also to conduct a qualitative analysis…arrow_forward
- Is it possible for a company to have high profitability but a low ROE? Select an answer: It is possible, considering the three components of the DuPont framework. The DuPont framework suggests that a company with high profitability will always have a low ROE. The DuPont framework suggests that a company with high profitability will always have a high ROE. it is not possible, because ROE is based on a company's profitability in the previous year.arrow_forwardInvestment advisors estimated the stock market returns for four market segments: computers, financial, manufacturing, and pharmaceuticals. Annual return projections vary depending on whether the general economic conditions are improving, stable, or declining. The anticipated annual return percentages for each market segment under each economic condition are as follows: Assume that an individual investor wants to select one market segment for a new investment. A forecast shows improving to declining economic conditions with the following probabilities: improving (0.2), stable (0.5), and declining (0.3). What is the preferred market segment for the investor, and what is the expected return percentage? At a later date, a revised forecast shows a potential for an improvement in economic conditions. New probabilities are as follows: improving (0.4), stable (0.4), and declining (0.2). What is the preferred market segment for the investor based on these new probabilities? What is the expected return percentage?arrow_forwardHistorically small firm stocks have earned higher returns than large firm stocks. When viewed in the context of CAPM theory, this suggests that ____________. Group of answer choices small firms are better run than large firms government subsidies available to small firms produce effects that are discernible in stock market statistics small firms must be systematically riskier than large firms small firms are mis-pricedarrow_forward
- Suppose you are trying to decide whether to invest in a company that generates a high expected ROE, and you want to conduct further analysis on the company’s performance. If you wanted to conduct a comparative analysis for the current year, you would: Compare the firm’s financial ratios for the current year with its ratios in previous years Compare the firm’s financial ratios with other firms in the industry for the current year You decide also to conduct a qualitative analysis based on the factors summarized by the American Association of Individual Investors (AAII). According to your understanding, a company with one key product is considered to be risky than companies with a wide range of products. The American Association of Individual Investors (AAII) has identified several qualitative factors that should also be considered when evaluating a company’s likely future financial performance. Consider the scenario and indicate how you would expect the…arrow_forwardGuide Questions: 1. Is ABC, Inc. profitable? 2. Is the company's financial performance improving based on the two year data presented? 3. Is the company heavily financed by debt or equity? 4. Provide interpretation of the Horizontal and Vertical Analysis and Ratio Analysis (A). 5. From the computation (A), assuming that there is no pandemic, How do you see ABC, INC.? Is it profitable? Good for long term investment? Short term investment? Is the company still existing?arrow_forwarda. Enumerate four (4) factors to consider in analyzing the domestic economy as part of fundamental analysis. b. Distinguish between time limit orders and Limit orders c. Explain the following Investment ratios and indicate how they are computed:Earnings per share (EPS) and Price/Earnings ratio (P/E).d. What is market efficiency? Differentiate between weak and semi strong form efficiency e. Next Pharmacy Ltd, an all equity finance company has started the production of a vaccine against COVID-19. The popularity of the vaccine is such that it expects to pay its shareholders dividends of ȼ150 which grows steadily at 10%. The company has a beta of 1.75. The risk-free rate is 5% and the expected return on the market is 18.34%.Required: Calculate the stock’s required rate of return and price per share.arrow_forward
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