UNIVERSIDAD DEL PACÍFICO

Foundations of Finance
Academic Term: 2020- I
Instructors: Luis Robles (A) JPs: Nikoska Nicolas / Nicolás Gonzalez
Luis Robles (B) Noelia Pérez / Sofía Flores
David Wong (C) Gloria Carcamo / Priscila Quispe
Alexei Alvarez (D) Carlos Calderón / Cristóbal Pflucker
Fernando Bresciani (E) Percy Vega / Fernando Ruiz
Jeferson Carbajal (F) Eduardo Cordova / Pedro Blas
Carlos Arias (G) Renzo Morales / Mariana Pino

Question Bank – Topic 4 – Equity

1. When you value assets, you are implicitly assuming that

a. The market is always right
b. The market is always wrong
c. The market is sometimes wrong, but that it corrects itself eventually
d. The market is sometimes wrong, and that it does not correct itself eventually
e. None of the above

2. Why does a company usually execute a stock split?

a. To increase the stock price
b. To incentive institutional investors to buy the stock
c. To permit small investors buy a share
d. To increase the equity of the company

3. Currently, Volcan's share price is at US$1.17. You know that last year the company paid dividends of
US$0.08/share. Research analysts estimate that dividends will increase by 5% in the short-term (next 8 years),
and 3% there on. Do you think it's a good idea to buy Volcan's stock at the current price? Use the Gordon Model
to value the stock, consider a discount rate of 10.75%

4. Calculate the value of a stock that paid a US$1 dividend this year, if next year’s dividend will be 5% higher and
the stock will sell for US$13.45 at year-end. The required return is 13.2%

5. An analyst uses a temporary supernormal growth model to value a stock. The company paid a US$2 dividend
last year. The analyst expects dividends to grow at 15% each year for the next 3 years and then to resume a
normal growth of 7%. The analyst estimates that investors require a 12% return on the stock. What is the value
of this stock?

6. Consider the following companies, all of which have just paid a dividend of US$ 3 per share, but have different
growth expectations. Company A will grow at 30% for 2 years, and then its growth will immediately be reduced to
5% (because of the high growth); Company B will grow at 15% for 6 years and at a 6% growth rate onwards;
and, Company C will grow at 25% first year, 15% second year, and 6% thereafter. Which of them will have a
higher price today?

7. Consider a stock with dividends that are expected to grow at 20% per year for four years, after which they are
expected to grow at 5% per year indefinitely. The last dividend paid was US$1.00 and the required rate of return
is 10%. Calculate the value of this stock using a multistage growth model.
8. Your friend just bought a stock of ABC Company at US$35. You know that ABC’s earnings and dividends will
grow at 25% for two years, after which growth will fall to a constant rate of 6%. Considering that the projected
discount rate is 10%, and ABC’s most recently paid dividend was US$1.00, did your friend bought it overvalued,
undervalued or fairly valued?

9. A stock is not expected to pay dividends until three years from now. The dividend is then expected to be $2.00
per share, the dividend payout ratio is expected to be 40 percent, and the return on equity is expected to be 15
percent. If the required rate of return is 12 percent, calculate the value of the stock today

10. Company B paid a $1.00 dividend per share last year and is expected to continue to pay out 40% of its earnings
as dividends for the foreseeable future. If the firm is expected to generate a 10% return on equity in the future,
and if you require a 12% return on the stock, what is the value of the stock?

11. An analyst gathered the following information about a company:

- The stock is currently trading at US$31.00 per share.
- Estimated growth rate for the next three years is 25%.
- Beginning in the year 4, the growth rate is expected to decline and stabilize at 8%.
- The required return for this type of company is estimated at 15%.
- The dividend in year 1 is estimated at US$2.00.

Is the stock under or overvalud? How much?

12. You’ve been hired as a portfolio manager at an investment fund, and your first task is to value a local stock:
Sociedad Minera Cerro Verde (BVL:CVERDEC1). You know the following information about the firm: (PD1)

- Last period net income: US$ 451.3 MM

- Dividend payout ratio: 85%
- Discount Rate: 8%
- Share Outstanding: 350.1 MM
- Market Price: 29.50

You want to make a valuation for three possible scenarios for net income:
- The company doesn’t grow
- The company grows at a constant rate of 5%
- The company grows at 5% for 4 years, and 4% thereafter

Additionally, you have checked on Bloomberg that the company has a ROE of 22%.

Calculate the price you should pay under each case (including the implied growth rate of the company) and
evaluate whether it is a right choice to buy the stock.

13. Which of the following firms would most likely be appropriately valued using the constant growth DDM?
a. An established auto manufacturer with many years in the industry
b. A producer of bread and snack foods
c. A biotechnology firm in existence for two years

14. Which of the following methods is the best alternative to estimate the share price of a company that is in an early
stage and is not able to pay dividends because it is generating negative cash flows?
 a. Two-Stage Gordon Model
b. Comparable Companies: P/S
c. H – Model
d. Present Value of Cash Flows

15. Which of the following multiples can’t be used when a company has negative Net Profit?
a. EV/EBITDA
b. P/S
c. P/E
d. P/BV

16. A share of stock is expected to pay a dividend of $1.00 one year from now, with growth at 5 percent thereafter.
In the context of a dividend discount model, the stock is correctly priced today at $10. The value of the stock two
years from now should be

17. Mina is just starting to invest in equities, and wants to select the most suitable investment for her. She has the
following information about 3 companies: Enel, Bancolombia and Bitel

- Enel” has paid a dividend of $2.2, which will grow indefinitely at a stable annual rate of 3.2%.
- “Bancolombia” has just paid a dividend of $0.95, which is expected to increase at an annual rate of 12% for
the next five years. From year 6 up to year 8, the dividend will rise at an annual rate of 9% and from year 9
onwards it will remain constant.
- “Bitel” is expected to pay a dividend of $0.5 the next year. This amount will increase at an annual rate of
9.5% for the 5 years following that payment. From that time onwards it will grow at a 4% annual rate.

Mina thinks that the proper discount rate for both companies is 9.5%. What is fair value of each stock?

18. Luis is a guy who still has no clue what career to follow. However, he has always been interested in
investing his own wealth, so he is evaluating the value of two stocks in the airline industry, Alibanca
(AAB) and Ocopa Airlines (OA). He compiled information for the two companies in the following table.
Table 1 AAB OA
Current ROE 0.4 0.18
Current EPS $3.15 $4.30
Retention Ratio 0.25 0.45

a. What are the sustainable growth rates for each firm?

b. Luis decides to start by estimating the value of the two stocks using the constant growth dividend
discount model. Assume required returns of 11.2% and 10% for AAB and OA, respectively. Both
firms are expected to growth at their sustainable growth rates.
c. After further consideration, Luis feels the growth rates of Alibanca and Ocopa Airlines are likely to
decline after four years. He estimates Ocopa Airlines growth will decline from current 15.5% to
long-term 4.9% and Alibanca growth will decline from current 18.5% to long-term 6.8%. Luis
estimates the required rate of return for Alibanca and Ocopa Airlines to be 14.6% and 12.1%,
respectively. What are Luis estimated values of AAB and OA?

19. Consider the following two stocks:

a. Stock A is expected to provide a dividend of $10 per share forever.
 b. Stock B is expected to pay a dividend of $5 next year. Thereafter, dividend growth is expected to
be 4% a year forever.
If the discount rate for each stock is 10%, which stock is the most valuable? What if the discount rate is
7%?

20. You've decided that to pay US$25.00 for each stock of Sociedad Minera Cerro Verde (BVL:CVERDEC1). To be
sure of your decision, you plan to reinforce your analysis through a comparable valuation. Considering the
information from the companies in the following chart, are you still sure about your investment decision?
Company Price Shares Outs. Cash Debt Revenues COGS EBITDA Net Margin Industry
Unit US$ MM US$ MM US$ MM US$ MM US$ MM US$ MM % Revenues -
Ferreycorp S.A.A. 0.72 973.44 46.33 517.78 1,461 1,108 165 4.94% Equipments
Southern Copper Corporation 43.42 773.08 829.00 5,956.30 6,189 3,154 2,933 19.19% Copper Mining
Freeport-McMoRan Inc. 14.81 1,411.50 4,701.00 15,354.00 15,306 9,816 5,198 6.57% Copper Mining
Corporacion Aceros Arequipa S.A. 0.24 1,105.86 79.38 217.65 654 574 58 3.08% Steel
Anglo American plc 19.03 1,289.50 7,408.00 12,935.00 23,564 15,854 6,581 16.22% Copper Mining
Refinería La Pampilla S.A.A. 0.09 3,534.89 71.85 810.11 3,315 2,688 169 1.69% Oil & Gas
First Quantum Minerals Ltd. 11.79 685.78 1,407.00 6,178.00 2,842 2,575 972 -3.55% Copper Mining
Cementos Pacasmayo S.A.A. 2.58 504.60 15.21 297.77 367 218 111 8.29% Cement
Source: Capital IQ as of October 23rd, 2017

You know that the company total revenue for the last year was US$ 2,698.5MM, EBITDA US$ 1,189.0MM, Debt
of US$ 1,485.2MM, and Cash of US$ 200.4MM

21. Based on the following public information of Volcan Compañía Minera (BVL:VOLCABC1):

Income Statement US$ MM Balance Sheet

Total Revenue 821.50 Assets US$ MM Liabilities US$ MM
Gross Profit 240.30 Cash 203.40 Debt 843.70
Margin % 29.25% Accounts Receivables 69.10 Accounts Payable 211.20
EBITDA 238.20 Other Receivables 350.50 Other 508.00
Margin % 29.00% PP&E 1,021.40 Total Liabilities 1,562.90
Net Income 84.40 Intangibles 579.70 Equity US$ MM
Margin % 10.27% Other Assets 460.40 Equity 1,121.60
Shares Outstanding 3,858.52 Total Assets 2,684.50 Total Equity 1,121.60
Source: Capital IQ as of October 23rd, 2017

Determine Volcan’s share fair price if:

a. P/S multiple of its peers is 2.4x
b. EV/EBITDA of its peers is 7.5x
c. P/E of its peers is 21.8x

22. If you are looking for a cheap stock on a P/E ratio basis, which of the following combinations is the best one for
you?
a. Low P/E, high growth, high risk, high payout
b. Low P/E, high growth, low risk, high payout
c. Low P/E, high growth, low risk, low payout
d. Low P/E, high growth, high risk, low payout
e. Low P/E, low growth, low risk, high payout

23. If a company has 2'500,325 shares outstanding, a PVGO of 8.25 and Net Income of US$28'340,450. Calculate
the stock price and the Market Capitalization of the company. Consider a discount rate of 10.00%.
Additional exercises

24. Which of the following are disadvantages of the DDM?

a. To develop it, financial statements must be forecasted
 b. The model does not have theoretical background
c. The model is not widely accepted
d. It is necessary to estimate model's inputs
e. Model's output is too senstitive to its inputs

25. In which situation should the Multi-Stage Gordon Growth Model be employed?
a. When the growth rate (g) is assumed to change once or more over time
b. When the discount rate (r) is assumed to change once or more over time
c. When the growth rate (g) is assumed to be higher than the discount rate (r)
d. None of the above

26. Company XYZ was founded 4 years ago and is consolidating in the fast food restaurant business. Last year, the
company paid out a dividend of S/ 0.20 per share. The growth rate of the dividends is expected to be 4% for the
next 3 years and 6% for the remaining years. Assuming a 10% discount rate, what is the value of XYZ's stock
under the two-stage GGM model?

27. Company ABC had net income per share of S/ 5 in 2015, and distributed S/1.5 as dividends. Between 2016 and
2021, net income is expected to grow at an annual rate of 10% and the payout ratio is expected to remain
unchanged. From 2022 onwards, the growth of the net income will be 6% and the payout ratio will increase to
45%. The appropriate discount rate for the company is 15%. What is the value of the value of company ABC?

28. Valuation with multiples. See Excel file.