Case Study for Finance “Fundamentals of Investments”Case 5.2
Susan Lussier is 35 years old and employed
as a tax accountant for a major oil and gas explora- tion company. She earns
nearly $135,000 a year from her salary and from participation in the companys
drilling activities. An expert on oil and gas taxation, she is not worried
about job securityshe is content with her income and finds it adequate to
allow her to buy and do what- ever she wishes. Her current philosophy is to
live each day to its fullest, not concerning herself with retirement, which is
too far in the future to require her current attention.
A month ago, Susans only surviving parent,
her father, was killed in a sailing accident. He had retired in La Jolla,
California, 2 years earlier and had spent most of his time sailing. Prior to
retirement, he managed a childrens clothing manufacturing firm in South
Carolina. Upon retire- ment he sold his stock in the firm and invested the
proceeds in a security portfolio that provided him with supplemental retirement
income of over $30,000 per year. In his will, he left his entire estate to
Susan. The estate was structured in such a way that in addition to a few family
heir- looms, Susan received a security portfolio having a market value of
nearly $350,000 and about $10,000 in cash.
Susans fathers portfolio contained 10
securities: 5 bonds, 2 common stocks, and 3 mutual funds. The following table
lists the securities and their key characteristics. The common stocks were
issued by large, mature, well-known firms that had exhibited continuing
patterns of divi- dend payment over the past 5 years. The stocks offered only
moderate growth potential probably no more than 2% to 3% appreciation per
year. The mutual funds in the portfolio were income funds invested in
diversified portfolios of income-oriented stocks and bonds. They provided
stable streams of dividend income but offered little opportunity for capital

Now that Susan owns the portfolio, she
wishes to determine whether it is suitable for her situation. She realizes that
the high level of income provided by the portfolio will be taxed at a rate
(federal plus state) of about 40%. Because she does not currently need it,
Susan plans to invest the after-tax income primarily in common stocks offering
high capital gain potential. During the coming years she clearly needs to avoid
generating taxable income. (Susan is already paying out a sizable portion of
her income in taxes.) She feels fortunate to have received the portfolio and
wants to make certain it provides her with the maximum benefits, given her
finan- cial situation. The $10,000 cash left to her will be especially useful
in paying brokers commis- sions associated with making portfolio adjustments.
a. Briefly
assess Susans financial situation and develop a portfolio objective for her
that is con- sistent with her needs.
b. Evaluate
the portfolio left to Susan by her father. Assess its apparent objective and
evaluate how well it may be doing in fulfilling this objective. Use the total
cost values to describe the asset allocation scheme reflected in the portfolio.
Comment on the risk, return, and tax implications of this portfolio.
c. If Susan decided to invest in a security
portfolio consistent with her needsindicated in response to question
adescribe the nature and mix, if any, of securities you would recommend she
purchase. Discuss the risk, return, and tax implications of such a portfolio.
d. From
the response to question b, compare the nature of the security portfolio
inherited by Susan with what you believe would be an appropriate security
portfolio for her, based on the response to question c.
e. What
recommendations would you give Susan about the inherited portfolio? Explain the
steps she should take to adjust the portfolio to her needs.

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Case 6.2
Wally Wilson is a commercial artist who
makes a good living by doing freelance workmostly layouts and
illustrationsfor local ad agencies and major institutional clients (such as
large department stores). Wally has been investing in the stock market for some
time, buying mostly high-quality growth stocks as a way to achieve long-term
growth and capital appreciation. He feels that with the limited time he has to
devote to his security holdings, high-quality issues are his best bet. He has
become a bit perplexed lately with the market, disturbed that some of his
growth stocks arent doing even as well as many good-grade income shares. He
therefore decides to have a chat with his broker, Al Fried.
During their conversation, it becomes clear
that both Al and Wally are thinking along the same lines. Al points out that
dividend yields on income shares are indeed way up and that, because of the
state of the economy, the outlook for growth stocks is not particularly bright.
He suggests that Wally seriously consider putting some of his money into income
shares to capture the high dividend yields that are available. After all, as Al
says, the bottom line is not so much where the payoff comes from as how much
it amounts to! They then talk about a high-yield public utility stock,
Hydro-Electric Light and Power. Al digs up some forecast information about
Hydro-Electric and presents it to Wally for his consideration:

The stock currently trades at $60 per
share. Al thinks that within 5 years it should be trading at $75 to $80 a
share. Wally realizes that to buy the Hydro-Electric stock, he will have to
sell his holdings of CapCo Industriesa highly regarded growth stock that Wally
is disenchanted with because of recent substandard performance.
a. How
would you describe Wallys present investment program? How do you think it fits
him and his investment objectives?
b. Consider
the Hydro-Electric stock.
1. Determine the amount of annual dividends
Hydro-Electric can be expected to pay over the years 2013 to 2017.
2. Compute the total dollar return that
Wally will make from Hydro-Electric if he invests $6,000 in the stock and all
the dividend and price expectations are realized.
If Wally participates in the companys dividend reinvestment plan, how
many shares of stock will he have by the end of 2017? What will they be worth
if the stock trades at $80 on December 31, 2017? Assume that the stock can be
purchased through the dividend rein- vestment plan at a net price of $50 a
share in 2013, $55 in 2014, $60 in 2015, $65 in 2016, and $70 in 2017. Use
fractional shares, to 2 decimals, in your computations. Also, assume that, as
in part b, Wally starts with 100 shares of stock and all dividend expecta-
tions are realized.
c. Would
Wally be going to a different investment strategy if he decided to buy shares
in Hydro- Electric? If the switch is made, how would you describe his new
investment program? What do you think of this new approach? Is it likely to
lead to more trading on Wallys behalf? If so, can you reconcile that with the
limited amount of time he has to devote to his portfolio?


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