1. Use the information below to estimate the price for Google.
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Data from Yahoo Finance
|
GOOG
|
YHOO
|
FB
|
Industry
|
|
Market Cap:
|
477.59B
|
27.52B
|
268.58B
|
338.18M
|
|
Employees:
|
59,976
|
12,500
|
11,996
|
437.00
|
|
Qtrly Rev Growth (yoy):
|
0.13
|
0.07
|
0.41
|
0.20
|
|
Revenue (ttm):
|
71.76B
|
4.95B
|
15.94B
|
143.22M
|
|
Gross Margin (ttm):
|
0.63
|
0.64
|
0.84
|
0.54
|
|
EBITDA (ttm):
|
23.30B
|
477.08M
|
6.66B
|
6.64M
|
|
Operating Margin (ttm):
|
0.26
|
0.01
|
0.30
|
0.01
|
|
Net Income (ttm):
|
15.44B
|
242.25M
|
2.81B
|
N/A
|
|
EPS (ttm):
|
23.72
|
0.25
|
1.00
|
0.02
|
|
P/E (ttm):
|
29.27
|
116.56
|
95.35
|
29.23
|
|
PEG (5 yr expected):
|
1.53
|
-1.56
|
1.43
|
1.02
|
|
P/S (ttm):
|
6.85
|
5.79
|
17.45
|
3.38
|
Note: ttm = trailing twelve months; yoy = year over year
Market cap = market capitalization = market value of equity = price x shares outstanding
EPS is earnings per share, PE is the ratio of price to earnings (P/E ratio), PEG is the P/E ratio divided by the five-year expected growth rate, and PS is the price to sales ratio (the market capitalization divided by total sales.
a. What price would Google shares sell for if Google had the same P/E ratio as Yahoo?
b. What price would Google shares sell for if Google had the same market cap/EBITDA as Facebook? Assume the number of shares outstanding is 345.5 million.
c. Briefly compare your results to the current price of Google.
2. The investment department of Big Bucks Businesses (BBB) is examining several different strategies. The forecasting department has indicated that each economic state is equally likely to occur. The estimated return for each security under each state is below. Tarragon Inc. manufactures decorative bottles, and Vintner Corp. is a mining firm. The following table summarizes the data:
|
Economic State
|
Tarragon
|
Vintner
|
|
Recession
|
-11%
|
4%
|
|
Average
|
20%
|
8%
|
|
Boom
|
40%
|
6%
|
- Sara believes that BBB should invest 80% in Tarragon and 20% in Vintner. What is the return and variance on this portfolio? Use the population variance for the securities.
- Can Sara find a combination of Tarragon and Vintner that has no risk? If so, how much should BBB invest in each one? If not, explain why not.
3. You have the monthly returns for Rain Under Membranes (RUM) and for the S&P 500 (market). Use regression to estimate the characteristic line.
|
Months
|
RUM
|
S&P 500
|
|
Aug
|
0.09%
|
-3.10%
|
|
Sept
|
10.52%
|
3.49%
|
|
Oct
|
2.92%
|
4.43%
|
|
Nov
|
-6.10%
|
1.90%
|
|
Dec
|
5.49%
|
0.62%
|
|
Jan
|
-.84%
|
-2.88%
|
|
Feb
|
1.65%
|
1.34%
|
a. Find the alpha and beta for RUM. What does this tell you about RUM's stock?
b. What part of RUM's return is explained by the market?
4. Calliope Company is considering an investment of $60 million in plant and machinery. The property and machinery will be depreciated to a zero book value based on MACRS. It is in the 3-year property class. The firm has a 4-year planning horizon. The machinery will be sold at the end of 4 years for $5 million (there is no horizon value). The investment is expected to produce sales of $45 million in year 1 and $80 million in year 2 and to grow by 6% each year for the remaining two years. Cost of goods sold is expected to be 40% of sales and does not include the depreciation expense. Fixed operating costs are $4 million in year 1 and increase by 3% each year for the remaining 3 years. The tax rate is 40%. Net operating working capital is 2% of next year's sales.
a. Calliope has a target debt ratio (debt/value) of .30. The cost of debt is 10% and the cost of equity is 25%. Use the weighted average cost of capital (WACC) to find the net present value. Should Calliope invest? Why or why not?
b. Now you are told the project is riskier than the firm's average projects. How does this impact your decision?
5. Bar plans to finance a new project with $2M in bonds, $1M in preferred stock and $5M in retained earnings. These proportions are the same as their target weights.
- The zero coupon bonds have a 5-year life and sold for $680.58.
- The preferred stock has a $2.70 annual dividend. The preferred stock has a price of $30 but issue costs are $3 per share.
- Bar knows the Treasury bill rate is 3% and the market risk premium is 9%. The common stock has a beta of 1.20. The tax rate is 30%.
- The project has a 5-year planning horizon. It costs $8,000,000 and generates $2,100,000 in after-tax cash flows every year for 4 years followed by an after-tax cash flow of $4,100,000 in year 5. Find the net present value of the project using the WACC.
6. Hardy Enterprises is currently an all-equity firm with an expected return of 12%. They are considering a leveraged recapitalization in which they would borrow and repurchase existing shares.
a. Suppose Hardy borrows to the point that their debt-equity ratio is 0.50. With this amount of debt, their debt cost of capital will be 6%. What will be the expected return of their equity after this transaction?
b. Suppose instead Hardy borrows to the point that their debt-equity ratio is 1.50. With this amount of debt, their debt will be much riskier. As a result, their debt cost of capital will be 8%. What will be the expected return of their equity in this case?
c. A senior manager argues that it is in the best interest of the shareholders to choose the capital structure that leads to the highest expected return for the stock. How would you respond to this argument?
7. Dora wants to diversify with a new product line. The project requires an initial investment of $8,000,000 and will provide $1,040,000 in after-tax unlevered cash flows at the end of each year forever. The unlevered beta is .80. The tax rate is 40%. The T-bill rate is 4% and the expected return on the market is 12%.
a. Find the value of the project if they use no debt.
b. Now suppose $3,500,000 in debt will be issued. The firm's target debt ratio (debt/value) is 30.7%. The debt has a beta of 0, the tax shields are as risky as the debt, and the debt is perpetual (since the project lasts indefinitely). Find the value of the project using APV (adjusted present value) and FTE (flow to equity).
8. Dynamic Energy Systems is currently trading for $33 per share. The stock pays no dividends. A one-year European put option on Dynamic with a strike (exercise) price of $35 is currently trading for $2.10. If the risk-free interest rate is 4% per year, what is the price of a one-year European call option on Dynamic with a strike price of $35?
9. Rebecca is interested in purchasing a European call on a hot new stock, Up Inc. The call has an exercise (strike) price of $115, and expires in 90 days (Assume 365 days in a year). The current stock price of Up Inc. is $120, and the stock has a standard deviation of 40% per annum. The risk-free interest rate is 5% per annum (annually). Using the Black-Scholes formula, compute the price of the call.
10. Your firm wants to lease a $500,000 piece of equipment. The equipment has a 5-year life and a salvage value of $100,000 at the end of year 5. Depreciation is straight-line over 5 years to a zero book value. There will be 5 pre-paid lease payments on the equipment. Purchasing the asset has a positive NPV for your firm. Assume the tax rate is equal to 30%. The before-tax cost of debt is 7%. What is the maximum before-tax payment your firm is willing to make?