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Homework answers / question archive / Prepare this assignment according to the guidelines found in the APA Style Guide

Prepare this assignment according to the guidelines found in the APA Style Guide. An abstract is required. For a reverse 3 for 1 stock split, the number of shares will be decreased. Hence, the new outstanding number of shares will be 1,200,000 / 3 x 1 = 400,000 shares.

The price will increase to 48,000,000 / 400,000 = $120 per share.

Hudson Homes and Baldwin Construction

Return on Equity (ROE) is given as Net Income / Total Equity.

If net income is the same for both companies ($1 million) and so are the assets ($10 million each), the variation in the ROE (11.1% for Hudson and 20% for Baldwin) is attributed to the difference in the liability structure of the two companies.

Also, the above figures for ROE show that Hudson's equity is more than Baldwin's equity, thus Hudson's ROE is less than Baldwin's.

Since, equity = assets - liabilities. Hence, if Hudson's equity is high, its liabilities must be lesser than the other company. Calculations are shown below:

Hudson Homes

ROE = 11.1%

Net income = $ 1 million

Hence, Equity = Net Income / ROE = $9,009,009

Since, assets = $10 million

Hence, Liabilities = 10,000,000 - 9,009,009 = $990,991

Baldwin Construction

ROE = 20%

Net income = $ 1 million

Hence, Equity = Net Income / ROE = $5,000,000

Since, assets = $10 million

Hence, Liabilities = 10,000,000 - 5,000,000 = $5,000,000

As shown above, Hudson's liabilities are lesser than Baldwin's which is why there is a difference inequity of the two companies and hence the difference in return on equity.

Discussion

The most popular method for stock valuation is the 'Discounted Cash Flow' technique that takes into account the estimated stock price, dividend rates, and the growth rates together with the discount rate or expected return. It is based on the efficient market hypothesis that says that the listed stock price is close to the estimated fair value of the stock. The model takes into account the dividend growth rate and price growth rate to arrive at the expected future price of stock security.

The practical adjustments that might be required include a better estimation of the stock price through the market-based valuation of the stock. In addition, the market behavior of the stock must also be considered to arrive at its fair price.

Discussion

In an efficient equity market, though there is a lesser probability of a mispriced stock and hence a lesser probability of generating abnormal rates of returns. however, a financial analyst's job does not only have to deal with generating higher margins on the stock.

A financial analyst is required to consider the market trend and make a decision to purchasing or selling a specific stock and taking a particular position in the market. This would determine the level of profitability that the company can generate.

In addition, he/ she would be responsible to diversify risks in investing in a range of securities and keeping a low risk yet reasonable return portfolio. In reality, in an efficient equity market, the requirements for a well trained and intelligent financial analyst are higher than an ordinary market where anyone can make money.

However, to earn higher returns in an efficient market requires well thought out strategy and experience, and hence, a financial analyst's job becomes much more rewarding in these circumstances.