Foreign Investment Analysis Sevall Inc\'s Mexican Subsidiary, Cancunrocks, is ex

Question

Foreign Investment Analysis Sevall Inc's Mexican Subsidiary, Cancunrocks, is expected to pay Sevall 1 Peso per share in 1 year after all foreign and US taxes have been accounted for. The exchange rate in 1 year is expected to be $0.10 dollars per peso. After this, the peso is expected to depreciate against the dollar by 2% forever due to inflation differences between the US and Mexico. The peso denominated dividend is expected to grow at 7% a year indefinitely. Sevall owns 10M shares of Cancunrocks. Assuming that the cost of equity is 12%, what is the valuation of Cancunrocks in US dollars? Foreign Investment Analysis Sevall Inc's Mexican Subsidiary, Cancunrocks, is expected to pay Sevall 1 Peso per share in 1 year after all foreign and US taxes have been accounted for. The exchange rate in 1 year is expected to be $0.10 dollars per peso. After this, the peso is expected to depreciate against the dollar by 2% forever due to inflation differences between the US and Mexico. The peso denominated dividend is expected to grow at 7% a year indefinitely. Sevall owns 10M shares of Cancunrocks. Assuming that the cost of equity is 12%, what is the valuation of Cancunrocks in US dollars?

Explanation / Answer

We will have to calculate the equity value per share with the use of dividend growth model as follows:

Equity Value Per Share = D1/(Cost of Capital - Growth Rate)

Where D1 = $.10 and Growth Rate in US Dollars = 7% - 2% (inflation) = 5%

Using the values provided in the question, we get,

Equity Value Per Share = (1*.10)/(12% - 5%) = $1.428571

The total value of Cancunrocks holding is $14,285,714 (1.428571*10,000,000)

Answer is $14,285,714

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