You run a small private equity firm that specializes in identifying profitable acquisitions. You have identified the small, poorly managed, but profitable company GreenWatches, which has the following characteristics: ROE=7.5%, k=10%, b=60%, E1=3.
a. Just from these values, how do you know that GreenWatches is poorly managed?
b. What is the price (intrinsic value) of the stock and what is the current PVGO of the company? Why is the PVGO negative? You believe that you can turn around the company and increase its ROE to 11%. You believe that you can do so by streamlining operations and doing some downsizing. According to your plan you project the same earnings next year (equal to 3) and you project that, from that base, earnings will grow based on the new ROE and plowback ratio, which you plan to set to 40%.
c. What is the projected dividend next year and what is the new intrinsic value of the stock?
d. A large watch manufacturer figures out that you are trying to buy GreenWatches and decides to bid on it also. However, they do not have the skill to increase the ROE or make the other changes you are planning. The best they can do is to immediately set b=0. At what price does your competitor value GreenWatches?