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# Accounting: Capital Market Calculations

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1. Two stocks, i and j have the following probability distributions (see attached file). Calculate the expected returns, standard deviations and coefficient of variations for stocks i and j. Which stock would be preferred by the average investor? Explain why in your own words.

2. Calculate the return distribution of a portfolio, P, constructed of 60% in i and 40% in j.

3. Use the probability distribution in questions 2 above to calculate the expected return and standard deviation of the portfolio, P.

4. Use the expected returns of i and j to calculate the expected return on portfolio, P. Compare the answer in this question to the answer in question 3 above. What do you notice?

5. Assume that the risk-free interest rate is 3%, the expected return on the market is 8%, the beta of stock i is 1.50, and the beta of stock j is 1.8. Are i and j overpriced, underpriced or fairly priced?

6. Calculate the beta of portfolio, P. Given the beta of P and the information in question 5 above, is portfolio P overpriced, underpriced, or fairly priced?

#### Solution Summary

The problem set deals with topics under accounting: Capital Market computations.

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## Financial Planning and Working Capitol Management

1) Table 18.11 gives abbreviated balance sheets and income statements for Este Lauder Companies. Calculate the following ratios:

a. Return on assets.
b. Operating profit margin.
c. Sales- to- assets ratio.
d. Inventory turnover.
e. Debt-equity ratio.
f. Current ratio.
g. Quick ratio

2) Look again at Table 18.11. At the end of fiscal 2008 Este Lauder had 195 million shares outstanding 19 with a share price of \$ 45.50. The company's weighted- average cost of capital was about 10%. Calculate

b. Market- to- book ratio.
d. Return on capital.

3) Consider this simplified balance sheet for Geomorph Trading:
Current assets \$ 100 \$ 60 Current liabilities
Long- term assets 500 280 Long- term debt
70 Other Liabilities
190 Equity
Totals \$ 600 \$ 600

a. Calculate the ratio of debt to equity.
b. What are Geomorph's net working capital and total long- term capital? Calculate the ratio of debt to total long- term capital.

4) How would the following actions affect a firm's current ratio?
a. Inventory is sold.
b. The firm takes out a bank loan to pay its suppliers.
c. The firm arranges a line of credit with a bank that allows it to borrow at any time to pay its suppliers.
d. A customer pays its overdue bills.
e. The firm uses cash to purchase additional inventories.

5) Dynamic Futon forecasts the following purchases from suppliers:
Jan. Feb. Mar. Apr. May Jun.
Value of goods (\$ millions) 32 28 25 22 20 20
a. Forty percent of goods are supplied cash- on- delivery. The remainder are paid with an average delay of one month. If Dynamic Futon starts the year with payables of \$ 22 million, what is the forecasted level of payables for each month? b. Suppose that from the start of the year the company stretches payables by paying 40% after one month and 20% after two months. ( The remainder continue to be paid cash on delivery.) Recalculate payables for each month assuming that there are no cash penalties for late payment.

6) Abbreviated financial statements for Archimedes Levers are shown in Table 19.12 . If sales increase by 10% in 2011 and all other items, including debt, increase correspondingly, what must be the balancing item? What will be its value?

7) Table 19.15 on page 512 shows Dynamic Mattress's year- end 2007 balance sheet, and Table 19.16 on page 512 shows its income statement for 2008. Work out the statement of cash flows for 2008. Group these items into sources of cash and uses of cash.

8) The financial statements of Eagle Sport Supply are shown in Table 19.17 . For simplicity, Costs include interest. Assume that Eagle's assets are proportional to its sales. a. Find Eagle's required external funds if it maintains a dividend payout ratio of 60% and plans a growth rate of 15% in 2012. b. If Eagle chooses not to issue new shares of stock, what variable must be the balancing item? What will its value be? c. Now suppose that the firm plans instead to increase long- term debt only to \$ 1,100 and does not wish to issue any new shares of stock. Why must the dividend payment now be the balancing item? What will its value be?

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