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Financial Management

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A small company was founded by 2 electronic engineers, Tom and Jessica, 15 years ago. The company manufactures integrated circuits to capitalize on complex mixed-signal design technology and has recently entered the market for frequency timing generators, or silicon timing devices, which provide the timing signal or clocks necessary to synchronize electronic systems. Its clock products originally were used in PC video graphic applications, but the market subsequently expanded to include motherboards, PC PERIPHERAL DEVICES, AND OTHER digital consumer electronics, such as digital television boxes and game consoles. The company design and markets custom application-specific integrated circuits (ASICs) for industrial customers. The ASIC'S design combines analog and digital, or mixed-signal, technology. In addition to the two founders, Nolan Pittman, who provided capital for the company is the 3rd owner. Each owns 25 percent of the 1 million shares outstanding. Several other individuals, including current employees, own the remaining company shares.
Recently, the company designed a new computer motherboard. The company's design is both more efficient and less expensive to manufacture, and the ETI design is expected to become standard in many personal computers. After investigating the possibility of manufacturing the new motherboard, the company determine that the costs involved in building a new plant would be prohibitive. The owners also decided that they were unwilling to bring in another large outside owner. Instead, the company sold the design to an outside firm. The sale of the motherboard design was completed for an aftertax payment of $30 million.

Question - Jessica believes that the company should use the extra cash to pay off debt and upgrade and expand its existing manufacturing capability. How would Jessica's proposals affect the company?

The third owner is in favor of a share repurchase. HE Argues that a repurchase will increase the company's P/E ratio, return on assets, and return on equity. Are his arguments correct? How will a share repurchase affect the value of the company?

  • Financial Management -

    Take a shot. What do you think?

    Hint: Jessica wants to expand, Pittman wants to sit tight. In general, the investment decision rests on the expected rates of return.

  • Financial Management -

    You have to consider that rarely in life is there a free lunch. If the stock did not drop on an ex-dividend date, all else held constant, you could purchase the stock for the ex-dividend date; collect the dividend; then sell the stock at your purchase price, thus netting the dividend payment with virtually no capital risk. From a logical standpoint; the intrinsic value of the firm is lower when a dividend payment is made; as the firm now has less capital on hand as it paid out cash; reducing both its asset and equity balances while increasing its debt to equity ratio. Because of this; the intrinsic value of the firm is inherently lower, especially from an investor's standpoint. If you were to purchase the stock after the dividend payment, you now have a company in worse financial condition (albeit, not significantly worse by any means in most cases) and you need to be compensated for this risk. The lower share price takes this into account as it provides you with a higher potential future return.

  • Financial Management -

    The third owner is in favor of a share repurchase. HE Argues that a repurchase will increase the company's P/E ratio, return on assets, and return on equity. Are his arguments correct? How will a share repurchase affect the value of the company?

  • Financial Management -

    Stock A has an expected return on 12 % and standard deviation of 40%. Stock B has an expected rate of return of 18% and a standard deviation of 60%. the correlation coefficient between stock A and B is 0.2 %. What are the expected rate of return and standard deviation of the portfolio invested 30% in stock A and 70% on stock B?

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