Pat Riley is an artist who is on her way to a successful and promising career in the Theatre. Despite this apparent future success she is quite aware that this is a volatile profession. Therefore Pat has decided to diversify into investments. Pat will earn approximately US$500,000 this year. Being a fairly young woman, Pat has decided to invest in highly risky speculative growth stocks. Her broker has identified a particular stock that would fit nicely into her portfolio. The broker advised Pat to study the numbers and if it is deemed attractive, she should purchase 1,000 shares of the stock. Corporate sales for the company has been forecast for the next three years as follows:

Sal Year ($ in millions)

1. 22.5
2. 35.0
3. 50.0

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The company has 2.5 million shares of common stock outstanding. They are currently trading at $70 a share and pay no dividends. The company has a net profit rate of 20% with the stock trading at a P/E ratio of around 40 times earnings. Conditions are expected to hold well into the future.

Questions

1. What is the company's net profit and earnings per share (EPS) for the next 3 years?

1. What is the price of the stock in year 3?

1. Given that expectations hold and Pat buys the stock for $70 today and sells it in three years, determine her expected return on her investment. (time value of money calculations could assist) (3 marks)

1. What risk is she facing by purchasing this stock?

1. Should she consider the stock a worthwhile investment? Explain.

What do you consider the strengths and weaknesses of her investment programme?