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Include your answers and spreadsheet and upload them to the A2L Dropbox. The due date is November 6 at 11:59 PM. 1. Dividend Growth Model (10 points) Consider the following two equity-only firms: - Firm A and Firm B both just announced the annual earnings per share at $5; - Both firms’ earnings growth is going to be 5% forever, and both firms have a discount rate of 15%. - Firm A is going to distribute all its earnings as dividends to equity investors, while Firm B always retains 50% of the earnings. a. Compute the intrinsic values for both Firm A and B. Briefly explain why they are different. (5 points) b. Now suppose Firm B is going to grow its earnings at 10% forever (instead of 5%). What’s the intrinsic value of Firm B now? Briefly explain why it’s different from before. (5 points) 2. Fundamental Valuation (40 points) Use Yahoo Finance data to value the stock price of “GOOGL”. Download (or copy) the “Financials” and “Historical Data” from Yahoo Finance page of “GOOGL”. a. Free cash flow to equity. Work from the cash flow statement. Ignore the “TTM” values. Ignore the net borrowing. Follow this equation to compute FCFE for each of the 4 years: = + & − ℎ − Use the net income on the top line of the cash flow statement. Use D&A in the same statement. Use “Investments in property, plant, and equipment” as a proxy for CAPEX. Be ware that this number is already negative. Finally divide these numbers by “Diluted Average Shares” from the income statement for each year to arrive at the per share FCFEs. (10 points) b. Now go to historical data and download monthly stock prices from 1/1/2011 to 12/31/2022 for both “GOOGL” and “SPY”. Use “adjusted close” to compute monthly returns for both “GOOGL” and “SPY”. Run a simple regression of “GOOGL” returns on “SPY” to find the of “GOOGL”. Suppose the long-run risk-free rate is 2%, and the market risk premium is 6%. What is the estimated cost of equity for “GOOGL” according to CAPM? (10 points) c. Now you stand at the end of 2022 and are ready to project GOOGL earnings into the future. You consider GOOGL to be still innovative to have the next 10 years growing at a relatively fast pace. Use the income statement data to compute the average revenue growth rate in the past 4 years (that is, averaging the 3 revenue growth rates). Use this number as the first-stage growth rate for FCFE. After 10 years, you assume GOOGL’s FCFE is going to grow by 2% forever. Compute the intrinsic value of GOOGL share price based on the above assumptions. Make a recommendation based on GOOGL’s share price on 12/30/2022. (20 points) 3. Relative Valuation (40 points) You are interested in evaluating the following chip companies: - INTL - NVDA - AMD - QCOM a. Pretend that you are standing at the end of 9/30/2020. Compute the following ratios for all 4 firms: (10 points) o P/E, price-to-earnings, use net income divided by diluted number of shares o P/S, price-to-revenue (sales), use revenue divided by diluted number of shares o P/B, price-to-book (book value of equity, which is the total stockholder’s equity in the balance sheet), use total stockholder’s equity divided by diluted number of shares Make sure you use the adjusted close on 9/30/2020 as the price. Compute the average of the 3 ratios for all 4 firms: = + + 3 Then compute the average of the 4 firms’ valuation ratios and call it the industry ratio. Form a trading strategy where you should long the cheapest stock and short the most expensive stock. Clearly state which stock to long and which to short, and briefly explain the rationale. b. Download monthly price data for the long position stock and short position stock from 9/30/2020 to 09/30/2023. Compute the returns for both stocks. Compute the long-short portfolio returns. Compute the average return and volatility of this portfolio. Finally, compute the Sharpe ratio of this portfolio. (20 points) c. Briefly discuss one potential pitfall of relying on only relative valuation. (10 points) 4. Margin Requirements (10 points) Suppose you are a hedge fund manager. You only have two positions: - Cash position that is worth $4 billion. - Short position that is worth $8 billion. Your broker requires a 125% margin on your short position. a. How much extra cash should you post as margin other than the value of the short position? (5 points) b. On the next day, your short position moves against you by going up by 25%. How much extra cash must you post? Do you have enough cash to avoid a margin call? (5 points)