ESMT MBA Program, 2015, Module 3 Corporate Finance

Financial Markets and Corporate Decisions

Professor Guillermo Baquero, PhD

Assignment 2

Stock Valuation Deadline: Wednesday May 13, 13h59

The current stock price of Finovo Inc is $31 per share (end of 2014). The current dividend per share (for 2014) is $1.9. The market consensus is that Finovo Inc has a beta of 1.3, the coming years market return is 10%, and T-bills currently offer a 2.5% return. The ROE=10%, and the firm plans to maintain indefinitely its traditional retention ratio of 0.6

a) Calculate a constant- growth DDM value for Finovo Inc at the end of 2014 and compare the computed

value to its actual stock price. (estimated time to solve this problem 10min).

b) Assume that instead of having a retention ratio of 0.6, Finovo Inc would pay all earnings as dividends (i.e. a cash cow firm). Calculate the value of Finovo Inc as a cash cow firm. (estimated time to solve this problem 5min).

c) How would you interpret the difference between the values calculated in (a) and (b)? Would you conclude that Finovo Inc. is currently creating value for its shareholders, or not? Why? (estimated time to solve this problem 5min).

d) In fact, Finovo Inc could grow more rapidly (at 12%) over the next three years (2015, 2016, 2017) and then settle in at a lower but sustainable rate of growth from 2018 onwards. Calculate the two-stage DDM value for Finovo Inc. (estimated time to solve this problem 15min).