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Question 1: What is the appropriate valuation model for each of the four firms (A, B, C and D). Please explain all your answers. Firm A: The appropriate valuation model for Firm A is the dividend discount model. The dividend discount model is appropriate because Firm A is dividend-paying, and its dividends have a consistent upward relationship with its earnings. More specifically, using the Gordon growth model would be adequate to forecast future dividends of Firm A with a pattern of constant growth forever.

Firm B: Because Firm B invests large amounts to growth opportunities and does not pay dividends, the valuation of its stock can be done with a present value of growth opportunities model (PVGO). Since Firm B is in the growth stage, this model is appropriate to compare the present value of future investment opportunities in contrast to not taking the growth opportunities. If Firm B maintains a positive expected net present value from its growth opportunities, it won’t need to pay dividends.

Firm C: A multi-stage dividend discount model using the H-model is most appropriate for Firm C. The firm’s profits are slowly declining towards the mature phase growth rate. Since the decline in the growth rate is linear, starting from its supernormal growth to its normal rate, the H-model is the appropriate valuation model.

Firm D: A multistage dividend discounts model using the two-stage dividend discount model is appropriate for Firm D. With its patent expiring in three years, the supernormal growth rate the firm has been experiencing will abruptly decline and settle at a lower constant growth rate since it does not have any other drug in the pipeline. The two-stage dividend discount model uses initially a high growth rate for a certain period and then drops down to a sustainable growth rate into perpetuity.

Question 2: What is the current value for Maple Goods and Services stock? Show your calculations. Current dividend:

D0 = $3.00

Supernormal growth rate:

gs = 25%

Constant growth rate thereafter

gL = 7%

Transition period:

2H = 8 years

Required return:

r = 15%

Using the H-Model: V0= [D0*(1+gL)/(r-gL)] + [D0*H*(gs-gL)]/(r-gL) V0 = [$3.00*(1+0.07) / (1%-7%)] + [D0*H*(25%-7%)] / (15%-7%) V0 = $67.13 Answer: The current value for Maple Goods and services stock is $67.13

Question 3: What is the current value for Mataka Plastic stock? Show your calculations. Supernormal growth rate:

gs = 18%

Constant growth rate thereafter:

gL = 4%

Transition period:

2H = 4 years

Current dividend:

D0 = 5.00

Required return:

r = 15%

Using two-stage model: Dividendt = Dividend0 *(1+gs) t

Present value of dividendt = PV(D1) = Dt / (1+r) t

D1= $5.00(1+0.18)1

= $5.90

PV(D1) = $5.13

D2= $5.00(1+0.18)2

= $6.96

PV(D2) = $5.26

D3= $5.00(1+0.18)3

= $8.22

PV(D3) = $5.40

D4= $5.00(1+0.18)4

= $9.69

PV(D4) = $5.54

Present value of dividends over 1st 4 years = $(5.13+5.26+5.40+5.54) = $21.33 P4 = D5 / (r-gL) = $9.69* 1.04 / (15% - 4%) = $91.61 V0 = P 4 / (1+r)4 +Present value of dividends overs 1st 4 years = $91.61 / (1+0.15)4 + 21.33 = $73.71

Answer: The current value for Mataka Plastic stock is $73.71 Question 4: What is the percent of Wood Athletic Supplies leading P/E ratio related to PVGO? Show your calculations. Present value of growth opportunities:

PVGO

Current price:

V0 = 90

Expected earnings:

E1 = 6

Required return

r = 15%

PVGO Model using leading P/E1 V0 = E1/r + PVGO 90 = (6/0.15) + PVGO PVGO = 50 P/E ratio of PVGO = PVGO / V0 = 50/90 = 55.56%

Answer: The percent of Wood Athletics Supplies leading P/E ratio related to PVGO is 55.56%

Question 5: Are Pacious’s statements about the stages of growth and the Gordon Growth Model correct? Please explain your answers. - Statement 1 is incorrect. It is true that the initial growth phase has rapid increasing earnings, heavy reinvestments, and there are little or no dividends. However, companies in this phase usually have negative free cash flow to equity - Statement 2 is correct. The terminal value can be estimated by either applying a multiple to a terminal value of a fundamental or by using the Gordon Growth Model. A multiple to a projected terminal value could be earnings per share or book value per share....