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TUTORIAL 3
1. WRL is a company dedicated to the production of cookies in Quito, Ecuador. The 02nd of January
2007, the company bought an especial machine for making cookies that has been operating for the
last three years. The financial manager from the company, Mrs. Milagros Bardales, is considering
replacing this machine for a new more efficient one since the 2nd of January 2010.
According to the projections of Mrs. Bardales for the next four years, the company is expecting to
sell 300,000 packages of cookies per year at an average price of US$ 0.50 dollars per package.
You have been provided with the following information to help Mrs. Bardales to take the best
alternative, either to keep the old machine or to buy the new one:
Old Machine New Machine
Initial investment in the machine $ 80,000 $ 120,000
Machines’ salvage value for depreciation
purposes (according to their accounting useful
life)
$10,000 $ 20,000
Machine’s useful life (since acquisition) 7 years 4 years
Expected annual operating costs:
Variable cost per package of cookies
Fixed costs
$ 0.20
$15,000
$ 0.14
$ 14,000
Depreciation method Straight line Straight Line
Expected market selling prices for the machines:
2nd January 2010
31st December 2013
$ 40,000
$ 7,000
$ 120,000
$ 20,000
If WRL has an annual tax rate of 40% and the discount rate is 16% per year, you have to answer the
following questions (assume that all income and expenses are in cash in the year of their occurrence):
What is the Present Value of continuing operating with the old machine? Interpret your
calculation
What are the Net Present Value, the Internal Return Rate and the Profitability Index of
selling the old machine and purchasing the new one? Interpret each indicator
What is the best alternative to the company? Explain.
2. 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:
- 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:
- 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, and evaluate whether it is a right choice to
buy the stock.
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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, Gordon Model, consider a discount rate of 10.75%
4. Calculate the PVGO of each of the following companies. Consider a discount rate of 8%.
5. 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.
The stock is undervalued by approximately:
a. US$6.40.
b. US$15.70.
c. US$0.00.
The high growth in the first three years and the decrease in growth thereafter signals that we should
use a combination of the multi-period and finite dividend growth models (DDM) to value the stock.
6. Luis is a guy who still has no clue what career to follow. However, he has always been interested
in investing for his own, 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 more
likely to gradually decline over the next four years and therefore considers the H-model. 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?
Market Cap Shares Outs. Net Income
Facebook 498,941.00 2,904.20 13,155.00
General Electric 189,522.40 8,657.90 7,523.00
Ford 48,415.70 3,971.80 3,803.00
Walmart 262,814.00 2,987.20 12,729.00
Source: Capital IQ as of October 25th, 2017. Values in USD MM