ABC corporation stock is selling for Rs. 150 per share according to Karachi stock exchange market summary. A rumor about the company has been heard that the firm will make an exciting new product announcement next week. By studying the industry, it is being concluded that this new product will support a growth rate of 20% in dividend for two years. After that it is expected that the growth rate in dividend will decline to 6% and remains same onwards. The firm currently pays an annual dividend of Rs. 4.
The rate of return on stocks like ABC corporation is 10%.
Required:
I. Find out the values for D1, D2 and D3 (8 Marks)
II. What will be the price of stock (P2) at the end of year 2? (4 Marks)
III. What will be the present value (P0) of stock? (6 Marks)
IV. Should we buy stocks of ABC Corporation at Rs. 150? (2 Marks)
Solution
Find out the values for D1, D2 and D3
D1= 4 (1+0.2) =4.8
D2= 4.8 (1+0.2) =5.76
D3=5.76 (1+0.05) =6.11
What will be the price of stock (P2) at the end of year 2?
P2= 5.76 (1+0.2)/ .1-0.05
P2=138.24
What will be the present value (P0) of stock?
PO= 4.8/(1+.1)1 + 5.76/(1+.1)2 + 6.11/(1+.1)3 + 128.31/(1.1)3
= 110
Should we buy stocks of ABC Corporation at Rs. 150
As the present value of the stock is less then the current selling price so the stock should not be purchased.
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Q1. Keeping other factors constant, you are required to highlight the reasons for the increase in current ratio.
As per my suggestions if all other factors are kept constant than the reasons for increase in currents ratios are as followings
Solution:
1-Sweeping of Bank Accounts by company
2-Improved Current Asset by Rising Shareholder’s Funds
3-Sell-off Unproductive Assets by company
4-Pay off Current Liabilities
5-Faster Conversion Cycle of Debtors or Accounts Receivables
6-Increase in company cash balance with a long-term loan
7-Increase in current assets with new equity investments
8-Convertion fixed assets to cash by company
9-Pay off of some current liabilities
Q2. You are also required to suggest that, with company’s point of view, would this increase be considered as positive or negative. Give arguments in favor of your suggestion.
Solution :
The ideal current ration is supposed to be 2:1 means that current assests must be twice that that of current liabilities. If this ratio is less than 2:1 the short term financial position is not supposed to be too favourable but if its is more than this limit than it is showing idleless no working capital.
Here in this scenario
current ratio in 2009 is 1.2:1
current ratio in 2010 is 1.96:1
conclusion
Although increase in current ratio is positive sign but ratios in both years don’t match the standard requirements
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Q1. Keeping other factors constant, you are required to highlight the reasons for the increase in current ratio.
As per my suggestions if all other factors are kept constant than the reasons for increase in currents ratios are as followings
Solution:
1-Sweeping of Bank Accounts by company
2-Improved Current Asset by Rising Shareholder’s Funds
3-Sell-off Unproductive Assets by company
4-Pay off Current Liabilities
5-Faster Conversion Cycle of Debtors or Accounts Receivables
6-Increase in company cash balance with a long-term loan
7-Increase in current assets with new equity investments
8-Convertion fixed assets to cash by company
9-Pay off of some current liabilities
Q2. You are also required to suggest that, with company’s point of view, would this increase be considered as positive or negative. Give arguments in favor of your suggestion.
Solution :
The ideal current ration is supposed to be 2:1 means that current assests must be twice that that of current liabilities. If this ratio is less than 2:1 the short term financial position is not supposed to be too favourable but if its is more than this limit than it is showing idleless no working capital.
Here in this scenario
current ratio in 2009 is 1.2:1
current ratio in 2010 is 1.96:1
conclusion
Although increase in current ratio is positive sign but ratios in both years don’t match the standard requirements
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