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# Assume Meyer Corporation

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Assume Meyer Corporation is 100 percent equity financed. Calculate the return on equity (ROE), given the following information:

Earnings before taxes             \$1,500

Sales                                       \$5,000

Dividend payout ratio             60%

Total assets turnover              2.0

Tax rate                                   30%

Return on Equity (ROE) = 42 %.

Stewart Inc.’s latest EPS was \$3.50, its book value per share was \$22.75, it had 215,000 shares outstanding, and its debt ratio was 46%. How much debt was outstanding?

Total Outstanding Debt = \$4166620.37

You are an investor in high quality stock with average risk tolerance, and you currently hold a portfolio which yields a return of 16 percent, a beta of 1.0. The total value of your portfolio is \$200,000. Given a recent increase in salary, you decide to increase your portfolio by acquiring 800 shares of Xerox.  The current market price of Xerox is \$50 a share.  Xerox has an expected return of 11.5 percent with a beta of 0.75.  What will be the expected return of your portfolio (rP), and the new portfolio beta (βP), after you purchase the new stock?

New Expected Portfolio Return (rP) = 15.25%

New Portfolio Beta (βP) = 0.96.

Yonan Corporation’s stock had a required return of 11.50% last year, when the risk-free rate was 5.50% and the market risk premium (RPM) was 4.75%. Now suppose there is a shift in investor risk aversion, and the market risk premium increases by 2%. The risk-free rate and Yonan’s beta remain unchanged.  What is Yonan’s new required return?

rYonan = 14.03%

Rodriguez Roofing’s stock has a beta of 1.40, its required return is 11.25%, and the risk-free rate is 4.50%. What is the rate of return on the stock market implied by these facts (rMKT)?

Return on the Market (rMKT) = 9.32%

Today is your 23rd birthday. Your aunt just gave you \$1,000.  You have used the  money to open up a brokerage account  (today).  Your plan is to contribute an additional \$2,000  to the account each year on your birthday, up through and including  your 65th birthday, starting next year (for a total of 42 annual contributions).  The account has an annual expected return of 12 percent.  How much do you expect to have in the account right after you make the final \$2,000 contribution on your 65th birthday?

Future Value (FV) = \$ 2045442.09

For the annual contributions (Uniform Gradient Cash Flow)

For the \$1000

Total FV = 1928718.955+116723.1373 = \$2045442.092

Gomez Electronics needs to arrange financing for its expansion program. Bank A offers to lend Gomez the required funds on a loan where interest must be paid monthly, and the quoted rate is 8 percent. Bank B will charge 9 percent, with interest due at the end of the year. What is the difference in the effective annual rates charged by the two banks (that is, find ∆EAR)?

Difference in EAR = 0.70%

Bank A EAR =

Bank B EAR = 9%

Bank B EAR – Bank A EAR = 0.70%

You are given the following end-of-year cash flow information. The appropriate discount rate is 12 percent for Years 1 – 5, and then 10 percent for Years 6 – 10. Assume payments are to be received at the end of each year.  Hint: Although not required, you might find drawing the cash flow timeline helpful in solving this problem.

YEAR                        DOLLAR AMOUNT

1 – 5                                        \$20,000

6 – 10                                      \$25,000

What is the most you would be willing to pay right now (PV0) to receive the income stream presented above?

Value of Income Stream Today (PV0) = \$123673.59

Last year Rosenberg Corp. had \$195,000 of assets, \$18,775 of net income, and a debt-to-total-assets ratio of 32%. Now suppose the new CFO convinces the president to increase the debt ratio to 48%. Sales and total assets will not be affected, but interest expenses would increase.  However, the CFO believes that better cost controls would be sufficient to offset the higher interest expense and thus keep net income unchanged.  What was the original return on equity (ROE) for Rosenberg Corporation?  Assuming the president of the firm allows the CFO to increase the debt ratio, what will be the new ROE’?

Initial Return on Equity (ROE) = 14.16 percent

New Return on Equity (ROE’) = 18.52 percent

*Reference used is Gitman (2009).

Works Cited

Gitman, Lawrence J. (2009). Principles of Managerial Finance, 12th Ed. Philippines: Pearson Education South Asia PTE.

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