Chapter 13 Equity Valuation

Similar documents
CHAPTER 18: EQUITY VALUATION MODELS

Portfolio Management Philip Morris has issued bonds that pay coupons annually with the following characteristics:

Key Concepts and Skills. Chapter 8 Stock Valuation. Topics Covered. Dividend Discount Model (DDM)

Investment Analysis (FIN 383) Fall Homework 7

Valuation: Fundamental Analysis

Chapter 18. Equity Valuation Models

Chapter 13. (Cont d)

Valuation: Fundamental Analysis. Equity Valuation Models. Models of Equity Valuation. Valuation by Comparables

Chapters 10&11 - Debt Securities

FINA Homework 2

Practice Set #2 and Solutions.

Part B: The stock price is next year s dividend divided by the difference between the capitalization rate (r) and the dividend growth rate (g):

SECURITY VALUATION STOCK VALUATION

IMPORTANT INFORMATION: This study guide contains important information about your module.

Sample Final Exam Fall Some Useful Formulas

Level 2: Study Session 09: Equity Investments: Industry and Company Analysis 160 questions.

CHAPTER 4 SHOW ME THE MONEY: THE BASICS OF VALUATION

WEEK 10 Analysis of Financial Statements

Chapter 18. Equity Valuation Models

PowerPoint. to accompany. Chapter 9. Valuing Shares

Introduction to Stock Valuation

Introduction to Corporate Finance, Fourth Edition. Chapter 7: Equity Valuation

FI3300: CORPORATE FINANCE. Problem Set 2 Chapters 1-5

Chapter 6. Valuing Stocks. Fundamentals of Corporate Finance. Fifth Edition. Slides by Matthew Will. McGraw-Hill/Irwin

CHAPTER 9 STOCK VALUATION

12. Cost of Capital. Outline

Who of the following make a broader use of accounting information?

CHARTERED INSTITUTE OF STOCKBROKERS. September 2018 Specialised Certification Examination. Paper 2.5 Equities Dealing

Chapter 7. Analyzing Common Stocks. Security Analysis. Top-Down Approach Kaplan Financial

Chapter 14: Company Analysis & Stock Valuation

Full file at

Chapter 13 Capital Structure and Distribution Policy

Georgia Banking School Financial Statement Analysis. Dr. Christopher R Pope Terry College of Business University of Georgia

COPYRIGHTED MATERIAL. The Very Basics of Value. Discounted Cash Flow and the Gordon Model: CHAPTER 1 INTRODUCTION COMMON QUESTIONS

Wikipedia: "Financial Ratio" Contents. Sources of Data for Financial Ratios. Purpose and Types of Ratios

Lecture 4 Valuation of Stocks (a)

Aggregate Demand and Aggregate Supply

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

Fin 622 Quiz #4. MC : Imtiaz Sarwar

Chapter 9 Valuing Stocks

Security Analysis. macroeconomic factors and industry level analysis

Chapter 10 Selected Answers

Financial Markets Management 183 Economics 173A. Equity Valuation. Updated 5/13/17

ECON 1010 Principles of Macroeconomics Exam #2. Section A: Multiple Choice Questions. (30 points; 2 pts each)

Dcf Vs. Multiples. August 8, 2013 by Kurt Havnaer of Jensen Investment Management

MGTD75 Investments. Mid-Term Examination Winter 2008

CHAPTER 19 DIVIDENDS AND OTHER PAYOUTS

Chapter 17. Page 1. Company Analysis. Learning Objectives. INVESTMENTS: Analysis and Management Second Canadian Edition

Stock valuation. Chapter 10

MGT201 Current Online Solved 100 Quizzes By

Chapter 12 Cost of Capital

15.414: COURSE REVIEW. Main Ideas of the Course. Approach: Discounted Cashflows (i.e. PV, NPV): CF 1 CF 2 P V = (1 + r 1 ) (1 + r 2 ) 2

Choose the one alternative that best completes the statement or answers the question.

FN428 : Investment Banking. Lecture 23 : Revision class

1. An inventory turnover ratio of 10 means that, on average, items are held in inventory for 10 days.

Homework #2 Suggested Solutions

MIDTERM EXAM SOLUTIONS

PRACTICE EXAM QUESTIONS ON STOCK VALUATION


CHAPTER 19: FINANCIAL STATEMENT ANALYSIS

CIF Stock Recommendation Report (Spring 2015)

CFIN4 Chapter 2 Analysis of Financial Statements

Cornell University 2016 United Fresh Produce Executive Development Program

Firm valuation (1) Class 6 Financial Management,

Midterm Review. P resent value = P V =

Business 2019 Finance I Lakehead University. Midterm Exam

CHAPTER 10 EQUITY VALUATION: CONCEPTS AND BASIC TOOLS. Presenter Venue Date

CARRERAS LIMITED. Overview. S.W.O.T Analysis RECOMMENDATION: HOLD

ADMS Finance Midterm Exam Winter 2012 Saturday Feb. 11, Type A Exam

Introduction. Statistically, it is represented as, V o = D 1. ( E r -g) Where, D 1 = Next Year Dividend Per Share

This is Stock Valuation, chapter 10 from the book Finance for Managers (index.html) (v. 0.1).

CHAPTER 2 ANALYSIS OF FINANCIAL STATEMENTS

Short Term Investment Review as of March 31, 2016 May 2016

MGT201 Financial Management Solved MCQs A Lot of Solved MCQS in on file

METCASH (MTS) 5 th October 2014

Question # 1 of 15 ( Start time: 01:53:35 PM ) Total Marks: 1

Stock valuation. A reading prepared by Pamela Peterson-Drake, Florida Atlantic University

Papared by Cyberian Contribution by Sweet honey and Vempire Eyes

a. $1.00 b. $0.80 c. $1.60 d. $1.17 e. $ Which of the following statements is NOT correct about the rights

FINANCIAL MANAGEMENT (PART 16) DIVIDEND POLICY-II

Copyright 2017 AN Valuations BV. All Rights Reserved. Learning outcome statements (LOS) are copyrighted by CFA Institute and have been reproduced and

ACC 501 Quizzes Lecture 1 to 22

Blanchard, Amighini and Giavazzi, Macroeconomics: A European Perspective, 2 nd edition, Instructor s Manual on the Web

1. An inventory turnover ratio of 10 means that, on average, items are held in inventory for 10 days.

Dividend Policy. Supplement to Chapter 17 FIL 341 Prepared by Keldon Bauer

Market Expects 6% CAIGR (Cyclically Adjusted Implied Growth Rate) Dr. G. Kevin Spellman, CFA Coach Investing.com Date: 2/21/17

Chapter 6. Stock Valuation

OBSERVATION. TD Economics U.S. DEFICITS & DEBT: PAST, PRESENT & FUTURE

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

FINAL EXAM SOLUTIONS

INTRINSIC VALUE: A DISCUSSION

Economics of Money, Banking, and Fin. Markets, 10e

CHAPTER 9 NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA

7-2. Operating expenses vary directly with production and sales. A) True B) False

INVESTING IN LONG-TERM ASSETS: CAPITAL BUDGETING

Exploring the Economy s Progress and Outlook

Fundamentals of Corporate Finance, 3e (Berk/DeMarzo/Harford) Chapter 2 Introduction to Financial Statement Analysis

Cost of Capital, Capital Structure, and Dividend Policy

CHAPTER 2 RISK AND RETURN: PART I

November minutes: key signaling language

Transcription:

Chapter 3 Equity Valuation. = $9.9 2. (a) and (b) 3. a. = 2% b. $8.8 The price falls in response to the more pessimistic forecast of dividend growth. The forecast for current earnings, however, is unchanged. Therefore, the /E ratio decreases. The lower /E ratio is evidence of the diminished optimism concerning the firm's growth prospects. 4. a. False. b. True. c. Uncertain. 5. a. g = ROE b =.6 = 6.% = $.4; () = $23.33; /E =.67 b. VGO = E = $6.66 k c. g = ROE b =.4 = 4.% = $.6; () = $2.; /E =. VGO = $3.33 3-

6. a. g = ROE b =.8 = 8.% = $.; () = $25. b. 3 = ( + g) 3 = $3.49 7. a. This director is confused. In the context of the constant growth model, it is true that price is higher when dividends are higher holding everything else (including dividend growth) constant. But everything else will not be constant. If the firm raises the dividend payout rate, then the growth rate (g) will fall, and stock price will not necessarily rise. In fact, if ROE > k, price will fall. b. i. An increase in dividend payout reduces the sustainable growth rate as less funds are reinvested in the firm. ii. The sustainable growth rate is (ROE plowback), which falls as the plowback ratio falls. The increased dividend payout rate reduces the growth rate of book value for the same reason -- less funds are reinvested in the firm. 3-2

8. a. k = r f + (k M r f ) = 6% g = 6% = E ( + g) ( b) = $.6 b. Leading /E = 3.33 Trailing /E = 3.53 $.6 c. VGO = E = $-8.5 k The low /E ratios and negative VGO are due to a poor ROE (9%) that is less than the market capitalization rate (6%). d. Now, you revise the following: b = /3 g =.3 = 3.% = $2.6 V $5.85 V increases because the firm pays out more earnings instead of reinvesting earnings at a poor ROE. This information is not yet known to the rest of the market. 3-3

9. FI Corporation a. $6. b. The dividend payout ratio is 8/2 = 2/3, so the plowback ratio is b = (/3). The implied value of ROE on future investments is found by solving as follows: g = b ROE.5 = (/3) ROE ROE = 5% c. Assuming ROE = k, the price is (E /k) = $2 Therefore, the market is paying ($6 $2) = $4 per share for growth opportunities.. High-Flyer stock k = r f + (k M r f ) = 7.5% Therefore: $2. 2. a. It is true that NewSoft sells at higher multiples of earnings and book value than Capital. But this difference may be justified by NewSoft's higher expected growth rate of earnings and dividends. NewSoft is in a growing market with abundant profit and growth opportunities. Capital is in a mature industry with fewer growth prospects. Both the price-earnings and price-book ratios reflect the prospect of growth opportunities, indicating that the ratios for these firms do not necessarily imply mispricing. b. The most important weakness of the constant-growth dividend discount model in this application is that it assumes a perpetual constant growth rate of dividends. While dividends may be on a steady growth path for Capital, which is a more mature firm, that is far less likely to be a realistic assumption for NewSoft. c. NewSoft should be valued using a multi-stage M, which allows for rapid growth in the early years, but also recognizes that growth must ultimately slow to a more sustainable rate. 3-4

6. a. k = r f + (r M ) r f ] = 6% b. Year ividends 27 $.72 28 $.72.2 = $.93 29 $.72.2 2 = $2.6 2 $.72.2 3 = $2.42 2 $.72.2 3.9= $2.63 resent value of dividends paid in years 28 to 2: $4.82 23 2 $37.57 V (in 27) of 2 = $24.7 Intrinsic value of stock = $28.89 c. The table presented in the problem indicates that Quick Brush is selling below intrinsic value, while we have just shown that Smile White is selling somewhat above the estimated intrinsic value. Based on this analysis, Quick Brush offers the potential for considerable abnormal returns, while Smile White offers slightly below-market risk-adjusted returns. d. Strengths of two-stage M compared to constant growth M: The two-stage model allows for separate valuation of two distinct periods in a company s future. This approach can accommodate life cycle effects. It also can avoid the difficulties posed when the initial growth rate is higher than the discount rate. The two-stage model allows for an initial period of above-sustainable growth. It allows the analyst to make use of her expectations as to when growth may shift to a more sustainable level. A weakness of all Ms is that they are all very sensitive to input values. Small changes in k or g can imply large changes in estimated intrinsic value. These inputs are difficult to measure. 3-5

8. a. The value of a share of Rio National equity using the Gordon growth model and the capital asset pricing model is $22.4, as shown below. Calculate the required rate of return using the capital asset pricing model: k = r f + (k M r f ) = 3% Calculate the share value using the Gordon growth model: ( g) o $22.4 b. The sustainable growth rate of Rio National is 9.97%, calculated as follows: g = b ROE = Earnings Retention Rate ROE = ( ayout Ratio) ROE = ividends Net Income.997 9.97% Net Income Beginning Equity 2. Nogro Corporation a. = $ g = b ROE =. Therefore: k = 2.% b. Since k = ROE, the NV of future investment opportunities is zero: VGO E k $ c. Since k = ROE, the stock price would be unaffected if Nogro were to cut its dividend payout ratio to 25%. The additional earnings that would be reinvested would earn the ROE (2%). Again, if Nogro eliminated the dividend, this would have no impact on Nogro s stock price since the NV of the additional investments would be zero. 3-6

22. Xyrong Corporation a. k = r f + [E(r M ) r f ] = 6.4% g = b ROE = 2% V ( g) $.82 b. = V = V ( + g) = $4.4 E(r) = = 8.52% 3-7