Q. You are asked to value a small all-equity financed Start-up Company that is expected to generate a cash flow of -$50 million next year and -$30 million in the following year and -$5 million in year 3, before turning profitable in year 4. Its first positive cash flow equals $2 million, and the cash flows are expected to grow at a rate of 40% per year for 6 years (until year 10). After this period, the growth rate drops to 3.5% per year indefinitely. Value the start-up company if the relevant discount rate (or capitalization rate) is 11%.
Q. A U.K. firm expects to pay a dividend per share of £1.70 next year (paid annually) and expects the dividend to grow at a constant rate in the future. The firm’s beta equals 1.24. The risk free rate is 3%, and the expected return on the market index is 8%. Suppose you are an equity analyst using CAPM to compute the required return on the firm’s stock and the Dividend Discount Model to determine its intrinsic value. If the firm reinvests 25% of its earnings at an ROE of 12%, what is your estimate of the intrinsic value per share? If the stock is trading in the market at a forward P/E-ratio of 12.5, would you give a buy or a sell recommendation on the stock? Motivate your answer.
Q. Suppose you are an equity analyst following Google, and want to calculate the intrinsic value of the stock. You have determined that Google’s earnings for 2013 were $36.75 per share, and expect the earnings to grow at a rate of 18% in the next 5 years. During this period, Google is not expected to pay any dividends. You furthermore project that after 2018, Google will mature and will maintain a constant growth of 4% per year forever. The corresponding retention ratio would be 25%. The capitalization rate for Google is 7.85%. Based on this information, determine the value of a Google share. Which part of the value of the stock is due to growth? Explain your answer.
Q.Suppose you bought a high-yield bond with coupon rate of 8% (paid annually), a par value of $1,000 and a remaining maturity of 10 years on January 1, 2013. The yield to maturity at the time of purchase was 5%. If you sold the bond immediately after receiving the first coupon payment on January 1, 2014 and the yield to maturity was 7% at that time, what was your holding period return on the bond? Explain why the holding period return differs from the yield to maturity at the time of the purchase of the bond and identify all the sources of risk associated with holding this bond.
Q. Suppose you are a hedge fund manager looking for exposure to 300 shares in Apple, which currently trades at $500 per share. You are expecting an important patent ruling in one of Apple’s legal battles with Samsung, and anticipate this ruling to have a significant impact on Apple’s stock price. Since the direction of the ruling is unclear, you are considering a long straddle strategy by buying 6-month at-the-money call and put options. The 6-month risk free rate is 1% and the annual volatility of the returns on the stock equals 25%. You expect the stock price to either go up by $100 or go down by $75 in the next 6 months. Based on this information, what is the total cost of the long straddle strategy? Also discuss what you could do to (1) lower the cost of the volatility bet to less than $20,000, while preserving all the upside in the case of an unfavorable ruling, and (2) to benefit more from a favorable ruling on the trial, while preserving the upside of an unfavorable ruling. Motivate your approach and show all your calculations. You can include payoff profiles, where relevant.