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Problem: Orange, Inc. just paid an annual dividend of $10 out of earnings of $12. Analysts expect Orange's dividend and earnings to grow at a rate of 15% for the next 2 years. After two years, earnings and dividends will grow at 5% forever. The appropriate discount rate for Orange's equity is 10%. Please show all work.
Question 1: What is the fair market value for Orange?
Question 2: What is the present value of growth opportunities (PVGO) for Orange if Orange is priced fairly? Should Orange continue its growth strategy?
Question 3: What is Orange's current ROE?
Question 4: If Orange's systematic risk were to increase, all else equal, what would happen to its P/E ratio? Why? You do not need to conduct any calculations.
Question 5: Now, use the free cash flow method to determine if Orange's equity is over or undervalued. The firm's current share price is $14.50. Orange's past year free cash flow to the firm was $100. Analysts predict Orange's free cash flow to the firm will grow at 5% forever. The firm's weighted average cost of capital is 8% and cost of equity is 10%. The firm has $500 in debt outstanding and 200 shares outstanding. Is Orange overvalued or undervalued?
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