Question

1. Last week, Newtown Plastics announced that it had developed a new plastic container that is stronger and more durable, yet easier to recycle. In response to this announcement, the firm's stock price rose from $21 a share to a high of $27 a share and has remained at that level. This is an example of a(n):

• pre-activity action.

• delayed reaction.

• over-reaction and correction.

• efficient market reaction.

• post-activity reaction.

2. Which one of the following statements is correct?

Multiple Choice

• Tippees are permitted to trade securities based on information they know is private.

• Trading on private information which you just happen to overhear is legal.

• Company insiders are not permitted to trade their employer's securities.

• Any trading based on information known to be private is illegal.

• Only tippers can be accused of illegal insider trading.

3. McKenzie, Inc. reported EBIT of $8.5 million for last year. Depreciation expense totaled $5 million and capital expenditures came to $2 million. Free cash flow is expected to grow at a rate of 2.5% for the foreseeable future. McKenzie faces a 40% tax rate and has a 0.50 debt to equity ratio with $20 million (market value) in debt outstanding. McKenzie's equity beta is 1.4, the risk- free rate is currently 5% and the market risk premium is estimated to be 7.5%. McKenzie has 10 million shares of common stock outstanding. What is the current value of a share of McKenzie stock?

• $8.45

• $10.25

• $6.62

• $5.83

• $7.32

Answer 1

1. Option D. efficient market reaction. The Efficient Market Hypothesis, or EMH, is an investment theory whereby share prices reflect all information and consistent with the company's actions

2. Option D. Any trading based on information known to be private is illegal.

3.

Asset Beta = Equity Beta / (1 + DE Ratio * (1 - Tax)) = 1.4 / ( 1 + 0.5 * 0.6) = 1.4 / 1.3 = 1.08

WACC = Risk Free Rate + Beta * Market Premium = 5% + 1.08 * 7.5% = 13.08%

FCF = EBIT * (1 - Tax) + Depreciation - Capital Expenditure = $8.5 Million * 0.60 + 5 Million - 2 Million

FCF = $8.1 Million

Equity value = Firm Value - Debt

Equity value = ($8.1 Million * 1.025) / (13.08% - 2.50%) - $20 Million

Equity value = $78.30 Million - $20 Million

Equity value = $58.30 Million

Per Share Value = $58.30 Million / 10 Million Shares

Per Share Value = $5.83 Per Share Option D