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hw6solf.doc-Proposed Solution to Homework 6 1.
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hw6solf.doc-Proposed Solution to Ho...
hw6solf.doc-Proposed Solution to Homework 6 1.
##### Page 1
Proposed Solution to Homework 6
1.
Announcing a new popular product should lead to an extremely rapid increase in
the stock price of the firm.
If the stock price did not adjust rapidly and fully to the new
information, investors would have a strong financial incentive to identify this mispricing
and purchase shares of the firm.
Their purchases would tend to push the price to the
proper value based on the new information.
This process tends to be extremely fast when
important news about a firm is announced because analysts and investors recognize the
need to rapidly interpret the information and trade on that basis.
2.
If a corporate insider provided insider information to me it would be illegal for me
to trade on the basis of that information.
It would be very profitable especially if the
insider information is about to be revealed to other investors because the stock price
would soon move higher.
3.
Correctly identifying a stock as being undervalued and investing in the stock does
not guarantee you profits on your investment.
You need other investors to realize that
you are correct.
If that happens, the stock price will move to the correct level and the
investment will be profitable.
It is possible that investors will continue to be incorrect
and stock prices will not adjust.
The other investors do not have to literally realize that
you were right.
They could view some subsequent information (such as future earnings
levels) that leads them to adjust their estimate of the value of the firm in the direction that
corrects the pricing error you identified earlier.
4.
Earnings are \$94,745,000.
The number of shares outstanding is 17,462,465. So
earnings per share are \$5.43.
5.
Using a multiple of 18.04, the earnings per share of \$5.43 would suggest that the
value per share of Buffalo Wild Wings is \$97.96.
6.
Book value is \$518,039,000 so book value per share is \$29.67 (\$518,039,000 /
17,462,465)
7.
Market value is the product of 17,462,465 shares outstanding and \$160.10 price
per share, which equals \$2,795,740,647.
8.
The price to earnings ratio is 29.484 (\$160.10 / \$5.43).

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9.
The market to book value can be calculated by comparing the market value of
\$160.10 per share with book value per share of \$29.67 or by comparing the market value
of \$2,795,740,647with the book value of \$518,039,000.
Both yield a market to book
value of 5.396.
10.
ROCE would be 0.184 (\$5.45 / \$29.67).
Here I used per share amounts to
calculate ROCE.
11.
This ROCE of 0.184 is more than the required rate of return of 0.10.
Assuming
that this ROCE persists, the value of the firm should be more than the book value.
12.
V(2016) = BV(2016) + [ROCE(2017) – r]*BV(2016) / (1 + r) +
[ROCE(2018) – r]*BV(2017) / (1 + r)
2
+ [ROCE(2019) – r]*BV(2018)] / [(r – g)*(1 +
r)
2
]
ExpEarnings(2017) = 5.45
ExpEarnings(2018) = 6.65
ExpEarnings(2019) = 8.00
BV(2017) = BV(2016) + ExpEarnings(2017) - dividends
BV(2018) = BV(2017) + ExpEarnings(2018) - dividends
If we assume dividends are zero then we get
BV(2017) = \$29.67 + \$5.45 = \$35.12
BV(2018) = \$35.12 + \$6.65 = \$41.77
ROCE (2017) = 5.45 / 29.67 = 0.1837
ROCE (2018) = 6.65 / 35.12 = 0.1894
ROCE (2019) = 8.00 / 41.77 = 0.1915
V(2016) = 29.67 + [(0.1837 – 0.10)*29.67] /1.10 + [(0.1894– 0.10) * 35.12] / 1.21 +
[(0.1915 – 0.10) * 41.77] / [(0.10 – 0.03) * 1.21] =
29.670 + 2.258 + 2.595 + 45.123
= 79.65