Finance
Exercise 1
| Exercise 1 (12 points): Answer the following questions related to dividend discount valuation models. | |||||||
| (a) | Assuming a payout ratio of 100%. Calculate the value per share of Firm A. | ||||||
| Firm A | |||||||
| k (Discount Rate) | 12% | ||||||
| EPS_1 | $5.00 | Payout Ratio | 100.00% | ||||
| ROE | 15% | Retention Ratio | 0.00% | ||||
| Growth Rate | 0.00% | ||||||
| Value of Firm A (No Growth) | |||||||
| (b) | Suppose Firm A decides to permanently change its payout ratio to 50%. What is the new value per share of the firm? | ||||||
| Payout Ratio | 50.00% | ||||||
| Retention Ratio | 50.00% | ||||||
| Growth Rate | 7.500% | ||||||
| Value of Firm A (Constant Growth) | |||||||
| (c) | Due to investor demand for dividend income, Firm A decides that it is only willing to decrease the payout ratio to 50% for the next 5 years. In year 6, they will increase the payout ratio back to 100% (i.e., Div_6 = EPS_6). Calculate the value of the firm per share in this scenario. (Hint: This will require annuity and perpetuity formulas) | ||||||
| Years of Growth | 5 | ||||||
| Value of Firm A (Two Stage Growth) | |||||||
| (d) | How many years of investment at a 50% retention ratio will Firm A need to undergo before becoming a cash cow (100% payout) so that the value of the firm increases to $50/share? (Hint: Set the formula up as in (c) and use Solver to determine years of growth) | ||||||
| Years of Growth | |||||||
| Value of Firm A (Two Stage Growth) | |||||||
Exercise 2
| Exercise 2 (18 points): Using only the information below, answer the following questions regarding AAPL and AMZN common stock valuation. | ||||||
| AAPL | AMZN | (a) | Calculate the price-to-book ratio for AAPL and AMZN respectively: | |||
| Market Value of Equity / Capitalization (USD billions) | $1,960 | $1,584 | ||||
| Shares Outstanding (billions) | 4.2756 | 0.5009 | ||||
| P/B AAPL | ||||||
| Last Full Year Balance Sheet Items | P/B AMZN | |||||
| Book Value of Equity (USD billions) | $113.82 | $73.73 | ||||
| Book Value of Assets (USD billions) | $317.34 | $258.31 | (b) | Calculate the trailing price-to-earnings ratio for AAPL and AMZN respectively: | ||
| Last Full Year Income Statement & Cash Flow Items | ||||||
| Total Revenue (Sales, USD billions) | $273.88 | $321.78 | ||||
| Net Income (USD billions) | $58.42 | $13.18 | Trailing P/E AAPL | |||
| Depreciation Expense (USD billions) | $11.53 | $22.28 | Trailing P/E AMZN | |||
| Capital Expenditures (USD billions) | $8.30 | $24.26 | ||||
| Change in Working Capital (USD billions) | $0.83 | $3.63 | (c) | Calculate the forward price-to-earnings ratio for AAPL and AMZN respectively: | ||
| Market Expectations for Coming Year | Forward P/E AAPL | |||||
| Expected Total Revenue (Analyst Consensus Estimate, USD billions) | $305.89 | $432.53 | Forward P/E AMZN | |||
| Expected Net Income (Analyst Consensus Estimate, USD billions) | $64.53 | $22.76 | ||||
| Expected Net Income Growth Rate (Annual, Percentage) | 11.47% | 23.82% | d) | Using the Forward P/E calculated in part (c), calculate the price-to-earnings growth (PEG) ratio for AAPL and AMZN respectively | ||
| PEG Ratio AAPL | ||||||
| PEG Ratio AMZN | ||||||
| e) | Calculate the price-to-free cash flow ratio for AAPL and AMZN respectively (Specifically, use market value and trailing free cash flow to the firm. You should use Net Income rather than EBIT*(1-Tax Rate) in your calculations): | |||||
| P/FCF AAPL | ||||||
| P/FCF AMZN | ||||||
| f) | Based on your answers in (a) through (e), would you rather buy AAPL, AMZN, or neither? Briefly explain your answer. | |||||
| AAPL / AMZN / Neither | ||||||
| Why? (1 or 2 Sentences) | ||||||
Exercise 3
| Exercise 3 (20 points): You are considering several strategies involving the common stock and options of Goldman Sachs (GS). You have determined that there are three possible states of GS stock price 6 months from now: (1) Decline of 25%, (2) Unchanged, (3) Increase of 35%. Use this information to answer the following questions. (You should assume that the risk-free rate is zero. That is, any premiums received will have the same time value 6 months from now. You should also assume that no dividends are paid over the holding period. For consistency purposes, calculate HPRs with only the current stock price as the denominator and combined stock and options net profit or loss in the numerator) | |||||||
| (a) | First, consider a covered call strategy involving the purchase of GS stock and a $230 strike price call. What is the 6 month holding period return (before any taxes) from this covered call strategy in all three return states? | ||||||
| Call Strike Price | $230 | ||||||
| Call Premium | $2.75 | ||||||
| Covered Call HPR with GS Decline | |||||||
| Covered Call HPR GS Unchanged | |||||||
| Covered Call HPR with GS Increase | |||||||
| Current GS Stock Price | $210 | ||||||
| (1) Decline in Down State | -25% | (b) | Next, consider a protected put strategy involving the purchase of GS stock and a $190 strike price put. What is the 6 month holding period return (before any taxes) from this protected put strategy in all three return states? | ||||
| (2) Unchanged Return | 0% | ||||||
| (3) Increase in Up State | 35% | ||||||
| Option Time to Expiration (Years) | 0.5 | ||||||
| Put Strike Price | $190 | ||||||
| Put Premium | $3.00 | ||||||
| 6 Month Options Chain for Goldman Sachs (GS) | Protected Put HPR with GS Decline | ||||||
| Call Price | Strike Price | Put Price | Protected Put HPR GS Unchanged | ||||
| $40.00 | $170 | $0.90 | Protected Put HPR with GS Increase | ||||
| $32.50 | $180 | $1.75 | |||||
| $24.00 | $190 | $3.00 | (c) | Finally, consider a collar strategy involving the purchase of GS stock, a call at a $220 strike price, and a put with a $200 strike price. What is the 6 month holding period return (before any taxes) from this collared equity strategy in all three return states? | |||
| $15.00 | $200 | $4.75 | |||||
| $9.00 | $210 | $10.00 | |||||
| $5.25 | $220 | $15.00 | |||||
| $2.75 | $230 | $21.50 | Call Strike Price | $220 | |||
| $1.25 | $240 | $33.00 | Call Premium | $5.25 | |||
| $0.75 | $250 | $40.00 | Put Strike Price | $200 | |||
| Put Premium | $4.75 | ||||||
| Collared Equity HPR with GS Decline | |||||||
| Collared Equity HPR GS Unchanged | |||||||
| Collared Equity HPR with GS Increase | |||||||
| (d) | Calculate the standard deviation of returns across each state of GS returns (assuming each state is equally likely to occur) for each strategy. If your boss tells you he/she needs you to minimize risk across all states, which of these three strategies (Covered Call, Protected Put, or Collared Equity) are you going to choose? | ||||||
| Standard Deviation of Covered Call | |||||||
| Standard Deviation of Protected Put | |||||||
| Standard Deviation of Collared Equity | |||||||
| Risk Minimizing Strategy | |||||||