Reference no: EM132799735

The calculations can be done in Excel or with a calculator. You should turn in either an Excel file with text box annotations or neatly hand-written answers scanned into a pdf file. Giving "just the answer" is not sufficient. Explain the answer briefly to the grader so that he or she can see that you understand why you got the number you got. This can be done by writing out an equation with some numbers, along with a short sentence or two. Please format your submission so it is easy to read.

Question 1: For the year that just ended, BigBadPharmaCorp ("BBPC" for short) paid a dividend of $3 per share. BBPC owns the patent on a blockbuster drug, but that patent will expire soon. Analysts estimate that BBPC's dividends will grow at 16% per year for the next four years (for simplicity, assume that the first dividend will be paid exactly one year from today). At that time, the patent will expire, and from that point on BBPC's dividends are expected to grow at a rate of 1.4% per year forever. BBPC's annual cost of equity is 12%. Suppose that the yield curve is flat, and risk-free yields are 3% per year for all maturities.

a) What is the intrinsic equity value per share for BBPC?

b) Suppose that the stock is currently trading at $40 per share. Based on your answer in part a), would you recommend a BUY or SELL for this stock? Why?

Question 2: GameGo Inc does not pay dividends, so the dividend discount model is not useful in valuing it. However, you still need to estimate the intrinsic value of GameGo. You estimate its numbers for 2021 as follows:

Revenue = $1,250m
Costs = $925m
Depreciation = $265m
Capital expenditures = $225m
Decrease in NWC = $10m
Taxes = $98m

To keep the calculations simple, suppose that if you used the numbers above to calculate GameGo's free cash flow, those free cash flows will occur is exactly one year from today. GameGo has 10 million shares outstanding and $100m of debt. Its weighted average cost of capital is 10% and its cost of equity is 12%. You expect that after 2021, GameGo's free cash flows to the firm will grow at 5% per year forever.

a) Using the information above, calculate the intrinsic value per share of GameGo's stock.

Hint: If you correctly calculate and discount FCFFs, you will get the total value of the firm. You need to subtract out its debt to get the total value of the firm's equity. Dividing that value of equity by the number of shares gives you the pershare intrinsic value of the stock.

b) The discount rate r and the growth rate g are important variables that affect valuation. A good analyst will perform a sensitivity analysis to evaluate the effects of reasonable changes in r and g on her valuation. Create matrix of the intrinsic value per share for discount rates r in the range 8%, 8.5%, 9%... all the way to 12% and for growth rates g in the range of 3%, 3.5%,..., 7%.

Hint: This is most easily done using the Data Table tool in Excel, which is a useful tool to have at your disposal.

c) What happens to the value per share as the discount rate increases (decreases)? Why does that happen?

d) What estimate of the intrinsic value would you get if you used a growth rate that was greater than the discount rate? Is this reasonable?