ECONOMICS, FINANCE AND GLOBAL BUSINESS INVESTMENT POLICY ASSIGNMENT
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- Show your work. Un-shown work will receive no points.
- Each of the questions is worth 7 points. The exception is the long problem, which is worth 30 points.
- You may work together, and you may interact on blackboard. Remember you can receive participation points for contributing. However, two of you at most can prepare a document together.
- I will not interpret the answers for you.
1. Because there is inflation of 4%, the central bank intervenes and decreases the money stock by 7%. Interest rates rise by 1%, or 100 basis points. Eventually, the intervention lowers the GDP and the interest rates as well as inflation. The GDP, in fact, decreases by 1.5%, the inflation rate becomes 1%, and the interest rates drop by 1.7%, or they fall from the initial level by70 basis points (.7 %.) Divide the analysis into two areas. First, address the initial effect on the bond and the stock market. Second, discuss both, after the effects have worked themselves out as I have indicated above.
2. Expound on an expansion in GDP and the effects on the stock market and bond market in two different cases. First, the economic growth does not induce inflation. Second, the economic expansion causes substantial increase in inflation. Specifically, the GDP rises by 2.5% and the inflation rises by 5.5%.
3. How do we forecast GDP? Explain the different components of it and the determinants of those components.
4. What tools have we got to foretell the values of the portions of the GDP?
5. Analyze the defense industry versus the digital mobile device industry in terms of
Ascertain that you include population, income, regulation and technology.
c) Business cycle
6. We have two individuals whom we have to advise about investments. The one is a twenty three year old who has gotten a job in investment banking and is receiving 150 k annually. The other is an eighty year old woman, Ms. Brown, who has $10 million in assets, as well as owns her house mortgage free. The expenses to sustain herself is 30k for her house costs and 45 k for all other costs. She has 2 children, and she wants to pass as many of her assets to them. Assume their return objectives and their risk profiles and recommend the appropriate investments for them.
7.a) Talk about two concepts to tell us about prospects of the firm.
b) Talk on the drawbacks of using ROE as a performance measure.
8. Define risk. Elaborate on the different cases of bheta. Explicate the 3 factors which affect it.
1. Cummings has EAT, depreciation expense, capital expenses, debt and debt principal payments of $9m, $2.8m, $1.3m, $40m and $1.5m respectively. Between the first and the second years, it has current assets of $11m and $13.4m and current debts of $5m and $6.1m respectively. Its unlevered bheta, D/E and t are 3, 40/60 and .4 respectively. The t bond rate is 2% and the risk premium is 8% and its sales are $90m. Cummings plows about 30% of its profits back into its business. Derive the value of Cummings, if the growth rate continues perpetually.
2. We know the following about Mansur. Total assets are $1000m, E is $700m, cash is $100m and the # of shares is 1m. We estimate that the market value of equity is 2 times the book value of it. Finally, a fire sale of the firm would bring 70% of the value to the co. Compute the book value, liquidation value, replacement value and enterprise value per share of Mansur.
3. Handout in class
The defense industry and the digital mobile device industry are both multibillion-dollar industries. In America, the defense industry, considered as the aerospace and defense industry, employed 1.05 million workers as of 2010 (Deloitte, p.3). These workers drew wages of $84.2 billion, contributing to federal taxes 15.4 billion in individual income tax, while the same at state level was $1.9 billion. The net income tax for these industries as of 2010 was an estimated $5.5 billion and $1.7 billion at the federal and state levels respectively. The United States is the world’s largest customer of this industry. The industry invests heavily in research to develop technological innovations. The industry faces competition from new and emerging countries. The industry suffers from a highly erratic and variable business cycle, with an estimated duration 17 to 25 years (Bussolini).
The digital mobile device industry is currently dominated by smartphone development and use. It is one of the most disruptive industries globally. Total shipments as of 2013 stood at 1.83 billion units, while that of 2012 was 1.73 billion (CCS Insight 4). The value of these shipments was about $303 billion. Apple, the dominant American player in the smartphone industry accounted for 35% while its top global competitor, Samsung, accounted for 39%. Competition in the industry continues to intensify, especially due to a fall in the barriers to entry. In terms of all mobile devices, global mobile subscription rates stand at 3.6 billion, over half the global population (GSMA 6). The industry has a very rapid business cycle due to the fast-paced nature of information technology change. The industry is one of the leading industry in terms of technological innovation, being a wholly technology industry.
The 23-year old investment banker is at the beginning of their career. Assuming that they have guaranteed job security, then they can expect a constant and steady revenue stream from their employment. In the short-term to mid-term, he will need to purchase housing as well as a vehicle. Moreover, he is also likely to be raising a family. Therefore, what he is in need of is an expansion of his capital base. Thus, the most likely return objective is capital appreciation. Additionally, his long-term investment objective may be to build a retirement fund. In terms of his risk appetite, it is assumed he has a high-risk profile. Based on these objectives and risk profile, the most suitable investment options would be medium to high-risk investment options, which have concomitantly high returns. He should build a portfolio comprising of equity options whose return is higher than the current inflation rate.
For eighty-year-old Ms. Brown, she is at the peak of her life. Her life has exceeded the average life expectancy and she therefore has presumably little life left to live. One can safely assume ten years. She would like to leave most of her assets to her two children and as such, her chief return objective is capital preservation. She may also be looking at current income in order to generate some income to cater for her current expenses (Reilly and Brown 44). Her risk-profile is likely to be a low-risk one, as she is merely looking for returns that are sufficient to cater for her expenses as she preserves her capital. Thus, she should invest in fixed-income securities such as stocks and bonds. She should greatly diversify her portfolio holding so that her investments are spread across a number of many different investment options. She should invest in defensive sectors. These include companies operating in pharmaceuticals or household consumer goods.
Some of the concepts that can be used to assess the prospects of a firm include profitability and liquidity. Profitability is simply a measure of a firm’s ability to earn income from its operations. This provides insight into its ability to grow. Liquidity, on the other hand, assesses the ability of the firm to meet its immediate obligations while maintaining positive cash flow.
ROE refers to the return on equity. It measures the firm’s profitability performance as a percentage of the shareholders’ investment into the firm. It has several drawbacks such as its susceptibility to artificial inflation, such as through the division of a smaller book value. Since the book value is the denominator, using a smaller book value yields a higher ROE. The book value is in itself reducible through processes such as stock buybacks, which reduce the magnitude of shareholders’ value. The net effect is that ROE does not provide a true reflection of a firm’s profitability. Another drawback of ROE is that it obscures company debt, since it only takes net income and shareholder’s value into consideration.
Risk refers to the likelihood that the actual returns on an
investment will not match the expected returns. Beta refers to the systematic
risk of an investment whereby there are three cases of beta. A beta of 1
indicates that the investment risk matches the market risk. A beta of less than
1 means that the investments risk is lower than that of the market while
conversely, a beta greater than 1 means the investment risk outweighs the
Bussolini, Jake. The Last Chapter: The Facts about the Last Days of Grumman. AuthorHouse, 2014.
CCS Insight. “Global Smartphone Market Analysis and Outlook: Disruption in a Changing Market.” Industry Analysis Report. 2014.
Deloitte. “The Aerospace and Defense Industry in the U.S.: A fiancial and economic impact study.” Industry Analysis. 2012.
GSMA. “The Mobile Economy.” Industry Analysis. 2015.
Reilly, Frank K. and Keith C. Brown. Investment Analysis and Portfolio Management. New York: Cengage Learning, 2011.