Introduction to Corporate Finance

PARt 2: VALUAtIoN, RISk ANd REtURN

Your investment adviser has sent you three analyst reports

for a young, growing company named Wild Rydes Pty

Ltd. These reports depict the company as speculative,

but each one poses different projections of the company’s

future growth rate in earnings and dividends. All three

reports show that Wild Rydes earned $1.50 per share in

the year just ended. There is consensus that a fair rate of

return to investors for this ordinary share is 12%, and that

management expects to consistently earn a 13% return on

the book value of equity (ROE = 13%).

ASSIGNMENt

1 The analyst who produced report M makes the

assumption that Wild Rydes will remain a small, regional

company that, although profitable, is not expected

to grow. In this case, Wild Rydes’s management is

expected to elect to pay out 100% of earnings as

dividends. Based on this report, what model can you

use to value a share of ordinary shares in Wild Rydes?

Using this model, what is the value?

2 The analyst who produced report N makes the

assumption that Wild Rydes will enter the national

market and grow at a steady, constant rate. In this case,

Wild Rydes’s management is expected to elect to pay

out 30% of earnings as dividends. This analyst discloses

news that this dividend has just been committed to

current shareholders. Based on this report, what model

can you use to value a share of ordinary shares in Wild

Rydes? Using this model, what is the value?

3 The analyst who produced report P also makes the

assumption that Wild Rydes will enter the national

market, but expects a high level of initial excitement

for the product that is then followed by growth at a

constant rate. Earnings and dividends are expected to

grow at a rate of 50% over the next year, 20% for the

following two years, and then revert back to a constant

growth rate of 9% thereafter. This analyst also discloses

that Wild Rydes’s management has just announced

the payout of 30% of the recently reported earnings to

current shareholders. Based on this report, what model

can you use to value a share of ordinary shares in Wild

Rydes? Using this model, what is the value?

4 Discuss the feature(s) that drive the differing valuations

of Wild Rydes. What additional information do you

need to garner confidence in the projections of each

analyst report?

mini case

VALUING SHARES

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