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Dara Simmons, a 40-year-old financial analyst and divorced mother of two teenage

children, considers herself a savvy investor. She has increased her investment
portfolio considerably over the past 5 years. Although she has been fairly
conservative with her investments, she now feels more confident in her investment
knowledge and would like to branch out into some new areas that could bring
higher returns. She has between $20,000 and $25,000 to invest.
Attracted to the hot market for technology stocks, Dara was interested in
purchasing a tech IPO stock and identified NewestHighTech.com, a company that
makes sophisticated computer chips for wireless Internet connections, as a likely
prospect. The 1-year-old company had received some favorable press when it got
early-stage financing and again when its chip was accepted by a major cell phone
manufacturer.
Dara also was considering an investment in 400 shares of Casinos International
common stock, currently selling for $54 per share. After a discussion with a friend
who is an economist with a major commercial bank, Dara believes that the longrunning bull market is due to cool off and that economic activity will slow down.
With the aid of her stockbroker, Dara researches Casinos International's current
financial situation and finds that the future success of the company may hinge on
the outcome of pending court proceedings on the firm's application to open a new
floating casino on a nearby river. If the permit is granted, it seems likely that the
firm's stock will experience a rapid increase in value, regardless of economic
conditions. On the other hand, if the company fails to get the permit, the falling
stock price will make it a good candidate for a short sale. Dara felt that the following
alternatives were open to her:
Alternative 1: Invest $20,000 in NewestHighTech.com when it goes public.
Alternative 2: Buy Casinos International now at $54 per share and follow the
company closely.
Alternative 3: Sell Casinos short at $54 in anticipation that the company's fortunes
will change for the worse.
Alternative 4: Wait to see what happens with the casino permit and then decide
whether to buy or short sell the Casinos International stock.
a. Evaluate each of these alternatives. On the basis of the limited information
presented, recommend the one you feel is best.
b. If Casinos International's stock price rises to $60, what will happen under
alternatives 2 and 3? Evaluate the pros and cons of these outcomes.
c. If the stock price drops to $45, what will happen under alternatives 2 and 3?
Evaluate the pros and cons of these outcomes.

In this case, the student has to evaluate several alternatives, given a limited
amount of information. The instructor can expect a variety of answers for each
question, which should provide for lively discussion and high student interest.
(a)
In evaluating the four alternatives one must consider: taxes (approximately
11 percent of the current $54 price would go to taxes if sold this year rather than
next); the volatility of the stock price (large swings in the price); and Daras attitude
toward risk (she seems to be risk-averse). Since a case can be made for any
alternative, each is listed below with its advantages and disadvantages.
Alternative 1Sell now at $54 and buy bonds: Taxes of $6 more per share now
rather than in four months would have to be paid; no possibility would exist for gain
or loss from future stock price movements. (This is the lowest risk alternative.)
Alternative 2Place a limit order to sell at $60: High risk, since this strategy does
nothing for a drop in price. With high volatility, the sell order may be exercised soon
with the tax consequences mentioned. (This alternative seems to limit Daras
potential gain, but not her loss.)
Alternative 3Place a stop-loss order to sell at $45: This eliminates much of her risk
of loss without limiting potential gain. If the stop-loss order is executed in the next
four months, tax considerations are not as important. If the stop-loss is not
executed during the next four months, new information may exist making other
alternatives more attractive. Even if the price drops to $45, the stock may sell for
less than $45. When executed, a stop-loss order becomes a market order and sells
at the market price. (This alternative provides for some risk.)
Alternative 4Hold the stock for 4 more months: This allows potential losses of $54
per share and unlimited potential gains. (This alternative is the most risky.)
Alternative 3 is probably the best choice here. Remember: many other
considerations go into common stock selection and management; these are
discussed in Chapters 5 through 7.
(b)
If the stock price rises to $60, under Alternative 2, the stock should be sold,
yielding a total profit of $2,400 ($6 per share 400 shares). A disadvantage of
alternative 2 is that if the stock price had risen to, say, $59 and then fallen, the
order would not have been executed. In addition, if the price goes to $60 in the next
four months, a much higher percentage will go for taxes.
If Alternative 3 were followed, the stop-loss order would not have been executed.
Alternative 3 would have helped Dara minimize her losses in the event of a price
decline.
(c)
If the price falls to $45, Alternative 2 would be meaningless and the limit
order would expire unexecuted. Any sale then would bring in approximately
$18,000 (400 shares $45 per share). Thus, Daras loss would be held to $3,600
(400 shares $54 per share 400 shares $45 per share). Under alternative 3,

the loss could be greater if the price fell below $45 before the sell order was
actually executed.

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