Chapter 4: Q1B (page 470)
In what circumstances would you choose to use a dividend discount model rather than a free cash flow model to value a firm?
To value the stock of growing companies that do not pay dividends.
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General Weed killers dominate the chemical weed control market with its patented product Weed-ex. The patent is about to expire, however. What are your forecasts for changes in the industry? Specifically, what will happen to industry prices, sales, the profit prospects of General Weedkillers, and the profit prospects of its competitors?
What stage of the industry life cycle do you think is relevant for the analysis of this market?
Shaar (from the previous problem) has revised slightly her estimated earnings growth rate for Rio National and, using normalized (underlying trend) EPS, which is adjusted for temporary impacts on earnings, now wants to compare the current value of Rio National’s equity to that of the industry, on a growth-adjusted basis. Selected information about Rio
National and the industry is given in Table 13.10 .
Compared to the industry, is Rio National’s equity overvalued or undervalued on a P/E-to-growth (PEG) basis, using normalized (underlying) earnings per share? Assume that the risk of Rio National is similar to the risk of the industry.
The FI Corporation’s dividends per share are expected to grow indefinitely by 5% per year.
a. If this year’s year-end dividend is \(8 and the market capitalization rate is 10% per year, what must the current stock price be according to the DDM?
b. If the expected earnings per share are \)12, what is the implied value of the ROE on future investment opportunities?
c. How much is the market paying per share for growth opportunities (that is, for an ROE on future investments that exceeds the market capitalization rate)?
Which of the following is consistent with a steeply upwardly sloping yield curve?
a. Monetary policy is expansive and fiscal policy is expansive.
b. Monetary policy is expansive while fiscal policy is restrictive.
c. Monetary policy is restrictive and fiscal policy is restrictive.
Use the following case in answering Problems 29 – 32:
Mary Smith, a Level II CFA candidate, was recently hired for an analyst position at the Bank of Ireland. Her first assignment is to examine the competitive strategies employed by various French wineries.
Smith’s report identifies four wineries that are the major players in the French wine industry. The key characteristics of each are cited in Table 12.6. In the body of Smith’s report, she includes a discussion of the competitive structure of the French wine industry. She notes that over the past five years, the French wine industry has not responded to changing consumer tastes. Profit margins have declined steadily, and the number of firms representing the industry has decreased from 10 to 4. It appears that participants in the French wine industry must consolidate in order to survive.
Smith’s report notes that French consumers have strong bargaining power over the industry.
She supports this conclusion with five key points, which she labels “Bargaining Power of Buyers”:
After completing the first draft of her report, Smith takes it to her boss, RonVanDriesen, to review. VanDriesen tells her that he is a wine connoisseur himself and often makes purchases from the South Winery. Smith tells VanDriesen, “In my report, I have classified the South Winery as a stuck-in-the-middle firm. It tries to be a cost leader by selling its wine at a price that is slightly below the other firms, but it also tries to differentiate itself from its competitors by producing wine in bottles with curved necks, which increases its cost structure. The end result is that the South Winery’s profit margin gets squeezed from both sides.” VanDriesen replies, “I have met members of the management team from the South Winery at a couple of the wine conventions I have attended. I believe that the South Winery could succeed at following
both cost leadership and a differentiation strategy if its operations were separated into distinct operating units, with each unit pursuing a different competitive strategy.” Smith makes a note to do more research on generic competitive strategies to verify VanDriesen’s assertions before publishing the final draft of her report.
If the French home currency were to greatly appreciate in value compared to the English currency, what is the likely impact on the competitive position of the East Winery?
a. Make the firm less competitive in the English market.
b. No impact, since the major market for East Winery is England, not France.
c. Make the firm more competitive in the English market.
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