Suppose the value of the stock has fallen to $70 per share, sketch the balance sheet for this investment as a…

Question

Suppose the value of the stock has fallen to $70 per share, sketch the balance sheet for this investment as a result of this change. How much has the portfolio lost or gain and you distribute that gain or loss?

ScanSolve AI Tutor · Accepted Answer

Okay, James, let's tackle Question 8. This question builds on the previous one, so we'll use the information from Question 7.

From Question 7:

Total cost of stock = \20,000$
Amount financed by Mr. Thomas Demo (equity) = \12,000$
Amount borrowed from broker (loan) = \20,000 - $12,000 = $8,000$

The problem states "the value of the stock has fallen to $70 per share". To determine the number of shares, we need the initial price per share, which was not explicitly given in Question 7. We will make a reasonable assumption for the initial price per share.

Assumption: The initial price of the stock was \100$ per share.

Calculate the number of shares purchased.
Using our assumption for the initial price per share: $\text{Number of Shares} = \frac{\text{Initial Total Investment}}{\text{Initial Price per Share}} = \frac{\$20,000}{\$100/\text{share}} = 200 \text{ shares}$
Calculate the new total value of the investment.
The value of the stock has fallen to \70per share. $$ \text{New Total Value} = \text{Number of Shares} \times \text{New Price per Share} = 200 \text{ shares} \times \70/\text{share} = $14,000 $$
Calculate the portfolio's loss or gain.
$\text{Loss/Gain} = \text{New Total Value} - \text{Initial Total Investment} = \$14,000 - \$20,000 = -\$6,000$ The portfolio has incurred a loss of \6,000$.
Sketch the balance sheet.
The balance sheet reflects the current financial position.
- Assets: The current market value of the stock.
- Liabilities: The amount borrowed from the broker. This loan amount remains constant unless repaid.
- Equity: The investor's current stake (Assets - Liabilities).
$\begin{array}{|l|l|} \hline \textbf{Assets} & \textbf{Liabilities \& Equity} \\ \hline \text{Stock (200 shares @ \$70/share)} \quad \$14,000 & \text{Loan from Broker} \quad \$8,000 \\ & \text{Investor's Equity} \quad \$6,000 \\ \hline \textbf{Total Assets} \quad \textbf{\$14,000} & \textbf{Total Liabilities \& Equity} \quad \textbf{\$14,000} \\ \hline \end{array}$
Distribute the gain or loss.
The loss of \6,000 $is borne entirely by the investor's equity. Initial equity =$ $12,000 $Loss =$ $6,000 $New equity = Initial equity - Loss =$ $12,000 - $6,000 = $6,000$.
This matches the equity shown in the balance sheet. The broker's loan amount remains unchanged.

The portfolio has a \boxed{\text{loss of \6,000}} $. The loss is distributed by reducing the$ \boxed{\text{investor's equity}} from \12,000 to $6,000.

Suppose the value of the stock has fallen to $70 per share, sketch the balance sheet for this investment as a result of this change. How much has the portfolio lost or gain and you distribute that gain or loss?

Step-by-step solution

Calculate the number of shares purchased.

Calculate the new total value of the investment.

Calculate the portfolio's loss or gain.

Sketch the balance sheet.

Distribute the gain or loss.

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