SECURITY ANALYSIS

Security Analysis Portfolio Management



Executive Summary

Powerline Network Corporation (PNC) is a closely held, public company, traded in the Over-the-Counter (OTC) market. The company manufactures products for computer users to the network lines over existing power lines. Current financial performance of the company is in relatively good state. Earnings growth, although there is some concern that the market may be underestimated, perhaps as a sign that our incomes are not considered stable. Fortunately, we have isolated the absorption of risk due to abuse of larger companies. Another problem is that the PNC does not pay dividends, which are incompatible with the industry. The hurdle for the project WACC of 10% or maybe a little higher. Our beta of the market suggests that we are moderately risky, but the markets do not believe that our projects are profitable enough. We can reduce the risk, return, WACC and the beta, but it is unclear whether this will solve our problems of perception.

Table of Content

Memo 14

Memo 26

Memo 39

Recommendations11

References12

Security Analysis Portfolio Management

Memo 1

The price that we should be willing to pay for a firm is reflected in its current market capitalization. However, if we are going to acquire a firm, shareholders usually expect a premium over the current market price to accept the offer. This is a problem for us: we will need to be able to justify why our valuation is higher than that of the market. This is a dangerous business, since there are marginal investors who have put their money on the line that we are wrong. Having said that, takeover opportunities do occur, these must involve either bad management (that we can rectify) on the part of the target, or else synergies like avoiding duplication (that we can exploit) (Bishop, 1994, 287). A problem with this is the observation that management may be a liability. This is common in acquisitions, which is why management of target firms is often fired after the acquisition. This is a problem because we would not be the first firm to fail to recognize that it is our own management that is a liability. In this case, our takeover desires are unfounded, and unlikely to be good for our shareholders.

The cost of existing preferred stock can be calculated as shown below:

Where: Dps is the dividend as the percentage of the face value and Pps is the current market price. The cost of new preferred stock has to contain the flotation cost:

Where F is the flotation cost in percentage of the face value. To calculate the cost of the optional sinking fund, we need to calculate the relevant cash flows associated with the issuance and financing of the fund. The sinking fund would require the company to retire 10 % of the original shares each year after issuance and the issuance would have 2% flotation cost.

2007

2008

2009

2010

2011

2012

2013

2014

$80.00

$70.00

$60.00

$50.00

$40.00

$30.00

$20.00

$10.00

$(10.00)

$(10.00)

$(10.00)

$(10.00)

$(10.00)

$(10.00)

$(10.00)

$(10.00)

$(4.20)

$(3.68)

$(3.15)

$(2.63)

$(2.10)

$(1.58)

$(1.05)

$(0.53)

$(14.20)

$(13.68)

$(13.15)

$(12.63)

$(12.10)

$(11.58)

$(11.05)

$(10.53)

IRR = Cost to company (pre-tax): 5.70%

As results we get the followings:

Cost of existing preferred stock: ...