I.  Multiple-based valuation

1.   Please refer to the information in Appendix 1 when answering the following questions.

a.   Compute Royal Caribbean’s forward PE ratio.  (2 points)

b.   Compute Royal Caribbean’s PEG ratio.  (2 points)

c.   Assume Carnival and Royal Caribbean have similar earnings growth and both companies are fairly priced, but Royal Caribbean has a higher dividend payout than Carnival. Do you expect Carnival to have a higher or lower PE ratio than Royal Caribbean?  (2 points)

d.   Solve for the price that would set Royal Caribbean’s PEG ratio equal to the industry PEG ratio of 1.2.  (2 points)

f.   Assume Carnival Corporation recorded significant impairment charges related to write downs of ships and goodwill. The charge was recorded in “other operating” expenses.

Please circle the correct response in each set.  These items will tend to make: (2 points each)

(1)  Royal Caribbean’s PE ratio higher than Carnival’s PE ratio

(2)  Royal Caribbean’s PE ratio lower than Carnival’s PE ratio

(3)  Will not affect the comparability of the PE ratios

(1)  Royal Caribbean’s forward PE ratio higher than Carnival’s forward PE ratio

(2)  Royal Caribbean’s forward PE ratio lower than Carnival’s forward PE ratio

(3)  Will not affect the comparability of the forward PE ratios

g.   Provide threefundamental reasons why Carnival might have a higher Operating ROA than Royal Caribbean. (3 points)

Question from Rob Desai presentation: (2 points-extra credit)

(i) What did Rob Desai do before working at Edward Jones?

(ii) Into which part of the energy value chain does EOG Resources fit:          Exploration and production, Services and Drillers, Transport, or Refining, Integrated?

Residual Income valuation

2.   What is the justification for predicting that abnormal earnings will decline to zero? (4 points)

3.   Why does ROE tend to exceed cost of equity even at the terminal calculation period? (2 points)

4.   Based on the spreadsheet in Appendix 4, compute the Carnival’s total (not per share) residual income in 2014 (2 points)

Note required

II.  Cost of Capital

1.   Asset pricing theory says the expected rate of return does not depend on unsystematic risk. Explain why?  (2 points)

2.   According to Yahoo! FINANCE, Carnival’s beta is 0.41 and Royal Caribbean’s beta is 0.79.  Provide two intuitive explanations for this difference?  (2 points)

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3.   Please refer to the information in Appendix 2 when answering the following questions.

a.   What is the estimated beta?  (2 points)

b.   Is this beta estimate significantly different from zero at the 5% level Yes / No ? (2 points)

c.   What is the alpha from this regression estimation? (2 points)

d.   Provide a brief (i.e., two-sentence) explanation of the alpha from this regression. (2 points)

4.   Please refer to the information in Appendix 3 when answering the following questions.

a.   Assume:

(1) the market risk premium is 7%,

(2) the risk free rate is 2 %,

(3) the small minus big risk premium is 3%, and

(4) the high book-to-market minus low book-to-market risk premium is 4%

Compute Royal Caribbean’s required cost of equity?  (3 points)

b.   Assumed at its current market capitalization, Royal Caribbean would be classified as a smaller firm. Are the 3-factor estimates consistent with this classification?  (2 points)

III.  Discounted Free Cash Flow Valuation

1.   Would Proceeds from sale of ships be added to or subtracted from “net cash     provided by operating activities” to compute free cash flow to equity in 2012?  (2 points)

2.   Would Cash paid during year for: Interest, net of amount capitalized be added to or subtracted from “net cash provided by operating activities” to compute free cash   flow to equity?  (2 points)

3.   Would Debt proceeds be added to or subtracted from “net cash provided by

operating activities” when computing free cash flow to equity?  (2 points)

4.   Would Dividends paid be added to or subtracted from “net cash provided by operating activities” when computing free cash flow to equity?  (2 points)

5.   Ignoring taxes, indicate which of the following would likely reduce operating cash flows.  (14 points)

6.   Please refer to the information in Appendix 4 when answering the following questions.

a.   Based on the discounted free cash flow spreadsheets, which firm has a higher expected market capitalization Carnival or Royal Caribbean?  (2 points)

b.   Based on the discounted free cash flow spreadsheets what factors are leading to the difference in the market capitalizations of these companies?  (2 points)

c.   According to the discounted free cash flow spreadsheet, would you rate Royal Caribbean a buy or a sell (circle)?  (2 points)

d.   Based on the assumptions in Royal Caribbean’s free cash flow spreadsheet, compute the amount of shareholder investment required to support $1 of      additional sales in 2014? (4 points)

e.   Based on the discounted free cash flow spreadsheets, what is the implied cost of debt for Carnival in 2014?    Does this interest rate make economic sense?  (2   points)

f.   Why might a company have a negative after-tax net interest rate on the spreadsheet? (2 points)