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Stock Price Change & Credit Risk

1. Assume that General Motors (BM) announces on September 30, 2011, that it expects its EPS to be $4.50 for the year ending December 31, 2011. At the time of the announcement, financial analysts are forecasting GM's annual EPS to be $5.00.
1. Would GM's earnings guidance announcement cause a change in its stock price on September 30?
2. Consider the following two scenarios:
a. The $0.50 difference between GM's management forecast and analysts' forecast is completely attributable to a previously reported month-long labor strike at one of GM's parts plants, a strike that disrupted production at most of the firm's car manufacturing facilities.
b. The $0.50 difference between GM's management forecast and analysts' forecast is attributable to GM's (previously undisclosed) decision to discontinue production of its line of sports utility vehicles and small trucks.
Do you expect the magnitude of the stock price change to be more in case (a) or case (b)?

2. Halifax Products has a $1 million bank loan that comes due next year. Management has prepared quarterly cash flow forecasts for each of the next six quarters as shown in the table below. Planned capital expenditures are intended to replace falling manufacturing equipment, upgrade computer systems, and refurbish the company president's office. These forecasts have been shared with the bank loan officer responsible for overseeing the Halifax loan.
Q1 Q2 Q3 Q4 Q5 Q6
Scheduled loan payments $500,000 $500,000
Forecasted cash flows:
Cash from operations $200,000 $250,000 $300,000 $240,000 $200,000 $200,000
Capital expenditures (150,000) (150,000) (175,000)
Dividends to owners (50,000)

1. Why might the loan officer consider the Halifax loan to be of high credit risk.
2. What steps can company management take to reduce the loan's credit risk?
3. What steps can the bank loan officer take to reduce the loan's credit risk?

Solution Preview

1. Assume that General Motors (BM) announces on September 30, 2011, that it expects its EPS to be $4.50 for the year ending December 31, 2011. At the time of the announcement, financial analysts are forecasting GM's annual EPS to be $5.00.
1. Would GM's earnings guidance announcement cause a change in its stock price on September 30?
Yes, a stock price change is expected. It is most likely to fall. This is due to the fact that that the price was based on the forecast, and with the lower EPS, comes lower stock prices. It is therefore expected to fall with the announcement.

2. Consider the following two scenarios:
a. The $0.50 difference between GM's management forecast and analysts' forecast is completely attributable to a previously reported month-long labor strike at one of GM's parts plants, a strike that disrupted production at most of the firm's car manufacturing ...

Solution Summary

The solution determines the stock price change and credit risk.

$2.19