a. Calculate the risk premium of each company in the pair. (5 marks)

• Use the estimated 5 year future EPS growth rate, not the dividend growth rate.

• Use the annual dividend which is calculated by adding up the dividends paid in the last 4 quarters. (Note: Apple has only paid 2 quarters of dividends; annualize the 2 payments)

b. Is the risk premium what you would expect, given what you know about the respective industries in which the companies operate? Explain your answer. (5 marks)

c. Do you conclude from the comparison of the risk premium for each company in the pair that the DDM has been applied in some form to arrive at the market price? Explain your answers. (5 marks)

ii. PEG ratio

a. Calculate the PEG ratio for each company in the pair that you have selected. (5 marks)

b. Which company in the pair represents the best investment opportunity according to the PEG ratio? Explain your answer. (5 marks)

c. Compare the DDM and PEG methods of equity valuation. What are the advantages and disadvantages of each? (5 marks)

Question #3

Working Capital Management – Accounts Receivable Financing (15 marks)

Jessica Cosmetics pledges receivables of $250 million per year to the Flint Finance Company, which advances cash equal to 80% of the face value of the accounts pledged. Jessica’s receivables are usually collected in about 36 days, so 10% of the annual amount advanced is generally outstanding at any time. Flint charges 14% interest, plus an administrative fee of 1.6% of the amount pledged.

Jessica is considering factoring its receivables. The factor operates without recourse and pays immediately upon taking over the accounts. It discounts the gross amount factored by 10% and pays Jessica immediately. Because the factor doesn’t collect from customers until they pay, it charges interest at 10% in the interim.

Required:

a. Calculate Jessica’s cost of pledging its receivables. State the result in dollar terms and as a percentage rate. Show your calculations. (5 marks)

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