Each of the following situations describes an event that affected the stock mark

Question

Each of the following situations describes an event that affected the stock market price of a particular company 1. The price of a common share of McDonnnell Douglas, Inc., increased by over $5 per share in several days after it was announced that Saudia Airlines would order $66 billion of commercial airliners from Boeing and McDonnell Douglas. 2. 3. Citicorp’s common stock price fell by over $3.50 per share shortly after the Federal Reserve Board increased the discount rate by ¼%. The discount rate is the rate charged to banks for short-term loans they need to meet their reserve requirements. 4. 5. The price of a common share of Ventitex, Inc., a manufacturer of medical devices, fell over $10 (27.7%) after it was announced the representatives of the Federal Drug Administration paid a visit to the company. Instructions For each of the independent situations described, explain the likely underlying rationale for the change in market price of the stock.

Explanation / Answer

(1) The price per share of McDonell Douglas Inc. would most probably be determined intrinsically through discounting either the company's annual dividend payments or its free cash flow to equity. Both cash flow streams would be influenced positively (will increase) by an expected potential increase in sales revenue owing to the large order from Saudia Airlines. Hence, the market anticipates this positive influence on the company's future cash flows and accounts for the resultant increase in intrinsic value of the stock by pricing in the potential sales revenue growth.

(2) An increase in short term borrowing rates would increase interest outgoes, thereby decreasing the free cash flow to equity or dividend payments. This in turn would depress the company's intrinsic share value which is reflected through a drop in market prices of the share.

(3) A visit by the FDA might lead to higher compliance costs for, imposition of fines/penalties on, ban on certain products of the company, thereby having the potential of effecting company free cash flows. This will lead to a fall in the intrinsic share value which is penciled in by the market in advance through a drop in its market share value.

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