Investment analysis and portfolio management 11th edition reilly solutions manual

Investment Analysis and Portfolio Management 11th Edition Reilly Solutions Manual Visit to download the full and correct content document: https://testbankdeal.com/dow nload/investment-analysis-and-portfolio-management-11th-edition-reilly-solutions-ma nual/

CHAPTER 10 THE PRACTICE OF FUNDAMENTAL INVESTING Answers to Questions 1.

Explanations and theories for underpricing include: 1. It is a way to compensate institutional investors for providing pricing information.

2. To the extent that the investor trusts the banker to systematically underprice the security based on the best available information, the investor will provide an accurate assessment of the value.

3. Bankers believe that the issuing company’s managers estimate their personal wealth based on the midpoint of the initial range. As a result, the initial range is set at a low level, knowing that the managers will feel much more pain if the range is adjusted down than they would feel joy if it were adjusted higher.

4. Bankers set prices low in order to minimize their litigation risk and/or to protect their reputational capital.

5. A bank may have an incentive to underprice the security in order to create a larger pool of profits, some of which the bank will receive back in the form of later commissions.

2.

During the early trading in the secondary market, the SEC allows the investment bank to help stabilize the price. The investment bank stabilizes the price by purchasing shares in the open market by using the overallotment option (also known as the green shoe option).

The overallotment gives the investment bank the right to buy 15 percent more shares within 30 days of the IPO.

3.

In a dirty auction, the issuing company could agree to sell the shares at a price below the clearing price. For example, even if $14 is the price at which 10 million shares could be sold, the stock may be issued at $13. There are bids for 18 million shares at $13 or higher.

Because there are 10 million shares that have to be split between investors who placed orders for 18 million shares, every bid could be filled at 10/18 or 5/9. In other words, if you bid for 900 shares, you will receive 500 shares.

4.

If an analyst is seen as influential within an industry, it is easier for the investment bankers in the firm to win banking business. This means that influential analysts can demand more compensation because they help bring in more investment banking business.

5.

Management should repurchase shares when they are trading below intrinsic value and pay a dividend when the shares are trading above intrinsic value. When the stock is trading at intrinsic value, management should be indifferent between a repurchase and a dividend (although taxable investors may prefer a share repurchase). Investors should also be aware that earnings per share increases that result from share repurchases are 10 - 1 © 2019 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

different from increases that occur because companies have increased revenue or cut expenses.

6.

Four important dates surrounding a dividend are as follows: 1. The declaration date: the date that a dividend is announced by the board of directors.

2. The date of record: the date on which the transfer agent “closes the book” and looks at who is the shareholder.

3. The ex-dividend date: the day on which the stock starts trading without the right to the dividend.

4. The payment date: the day the dividend is distributed.

7.

To a large extent, investors don’t worry about capital expenditures in the same way that they worry when companies do acquisitions. The reason for this is that companies are not paying a premium when they do capital expenditures. In addition, investors tend to assume that these investments will earn returns similar to historic returns. Most importantly, management understands the business, and these expenditures do not disrupt the business as an acquisition can.

8.

Poison pills were very unpopular with institutional investors because it’s hard to determine whether a poison pill is shareholder-friendly and whether management acted in shareholders’ best interest without looking at other evidence, such as compensation.

Poison pills require a supermajority of shareholder votes to approve selling the firm, selling the most profitable part of the company, and selling staggered boards. The fear was that poison pills deterred takeovers and helped entrench managers, and the evidence is not clear as to whether poison pills destroyed or created value for shareholders.

9.

Many investors disagree about whether top managers are overpaid and whether compensation is related to performance.

Arguments to say that CEOs are overpaid include: - Management may derive benefits from controlling resources that don’t create value for shareholders (this may lead to empire building to generate higher compensation).

2. Management has most of their wealth in this one company, so they may take too little risk (while the diversified investor wants them to take more risk).

3. Compensation is often short-term focused, which can result in management focusing on earnings per share rather than long-term value maximization.

Arguments to say that CEOs compensation is fair include: 1. It provides strong incentives to create shareholder value (and address the three issues described above).

2. It helps retain key talent (particularly in periods of poor performance attributable to market and industry factors).

3. It limits compensation cost to levels that maximize the wealth of shareholders.

10 - 2 © 2019 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

10.

Student Exercise.

10 - 3 © 2019 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 10 Answers to Problems 1.

1 (a).

1 (b).

Market Cap = 20 million shares x $19 = $380 million Underwriting fee = .07 x $16 x 20 million = $22.4 million Underpricing = ($19-$16) x 20 million = $60 million Total costs = $22.4 + $60 million +$1 million + $2 million + $0.5 million = $85.45 million

2.

Pre-cost equity value = market cap at end of first day = $380 million Total costs of going public = $85.45 million/$380 million = .2249 or 22.49%

3 (a).

15 percent overallotment of 20 million shares = 3 million shares 7 percent discount = $16 x (1-.07) = $14.88 Underwriter profit = ($16-$14.88) x 3 million shares = $3.36 million The underwriter has the right to buy 3 million shares from the issuing company for $14.88. This is the $16 offer price, but the underwriter is able to buy the shares at a 7 percent discount. In doing this, the underwriter makes an extra $1.12 per share profit on 3 million shares. The underwriter normally has this option for 30 days.

3 (b).

If the stock price immediately drops to $11.50 in the secondary market, the underwriter will not exercise its option. There is no reason for the underwriter to pay $14.88 for shares that it could buy in the open market for $11.50. The bank will pay $11.50 for 3 million shares that it sold for $16 for a profit on the short sale of: ($16-$11.50) x 3 million = $13.5 million

4.

In a traditional auction, all the winning bidders receive the auction clearing price of $19.

The investors who bid $20 pay only $19 and all their orders would be filled (2.5 million shares).

The investors who bid $19 pay $19 and all their orders would be filled (7 million shares).

The investors who bid $18 pay $19 but their orders will be partially filled (0.5 million shares).

5.

In a dirty auction, the issuing company could agree to sell the shares at a price below the clearing price at $17. There are bids for 18.5 million shares at $17 or higher. Because there are 10 million shares that have to be split between investors who placed orders for 18.5 million shares, every bid could be filled at 10/18.5.

The investors who bid $20 pay $17 and 1.351 million shares would be filled (2.5 x 10/18.5).

10 - 4 © 2019 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

The investors who bid $19 pay $17 and 3.78 4million shares would be filled (7 x 10/18.5).

The investors who bid $18 pay $17 and 2.162 million shares would be filled (4 x 10/18.5).

The investors who bid $18 pay $17 and 2.703 million shares would be filled (5 x 10/18.5).

6.

a. The declaration date is May 18. b. The date of record is June 13. c. The ex-dividend date is June 11. d. The payment date is June 28.

7.

7 (a).

If the company uses $300,000,000 to repurchase $35 shares, it will repurchase 8,571,429 shares.

According to the model, the $4,500,000,000 ($45 x 100,000,000 shares) company will become a $4,200,000,000 company.

Now, there are only 91,428,571 shares outstanding, and the intrinsic value should increase to $46.00 ($4,200,000,000/891,428,571 shares).

7(b).

PE multiple was 10, so EPS was (100,000,000 x $35)/10 = $3.50 per share or $350,000,000 in earnings.

After the repurchase, earnings per share increase from $3.50 to $6 per share ($350,000,000 divided by 91,428,571 shares).

7( c).

If the company pays a $300 million cash dividend the value of the company should drop from $3,500,000,000 to $3,200,000,000.

The value of the stock is now $3,200,000,000/100,000,000 = $32 per share

7( d).

Using a PE multiple of 10 earnings before the dividend are 35/10 = $3.50 per share The PE multiple after the dividend is $32/$3.50 = 9.14

8.

8 (a).

7(b).

If the company uses $300,000,000 to repurchase $35 shares, it will repurchase 8,571,429 shares.

According to the model, the $2,500,000,000 ($25 x 100,000,000 shares) company will become a $2,200,000,000 company.

Now, there are only 91,428,571 shares outstanding, and the intrinsic value should decrease to $24.00 ($2,200,000,000/891,428,571 shares).

PE multiple was 10, so EPS was (100,000,000 x $35)/10 = $3.50 per share or $350,000,000 in earnings.

After the repurchase, the earnings per share increase from $3.50 to $6 per share ($350,000,000 divided by 91,428,571 shares).

10 - 5

© 2019 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

8 (c).

If the company pays a $300 million cash dividend the value of the company should drop from $3,500,000,000 to $3,200,000,000.

The value of the stock is now $3,200,000,000/100,000,000 = $32 per share

8 (d).

Using a PE multiple of 10 earnings before the dividend are 35/10 = $3.50 per share The PE multiple after the dividend is $32/$3.50 = 9.14

9.

If the shares are sold for $20 per share, the issuing firm will receive: 10 million shares x (1- 0.07) x 20 = $186,000,000

10.

15 percent overallotment of 25 million shares = 3.75 million shares 7 percent discount = $18 x (1-.07) = $16.74 Underwriter profit = ($18-$16.74) x 3 million shares = $3.36 million The underwriter has the right to buy 3.75 million shares from the issuing company for $16.74. In doing this, the underwriter makes $18 - $16.74 = $3.26 per share profit on 3.75 million shares or $12,225,000.

If the underwriter used all its profits from the short position to purchase shares, it would purchase $12,225,000/$20 = 611,250 shares The underwriter would have purchased 3.75 million shares from the issuing company at $16.74 per share and 611,250 shares in the market at $20 per share for a total of 4,361,250 shares.

11.

Student Exercise.

10 - 6 © 2019 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.