Corpoarte Finance

Question 1

If Barrick operates without a hedging program using financial instruments, Barrick stock price would be more sensitive to gold price changes. The dynamics is that in the absence of hedge, Barrick’s revenue would change directly with gold price changes. Then net incomes, free cash flows and dividends would change in prompt response to gold price changes as well. No matter what valuation methodologies are used, the implied stock price changes would absolutely match gold price changes.

To further estimate percentage change of stock price in response to every 1% change in gold prices, we used the Dividend Discount Model as the benchmark scenario. We assume without the hedging program, the growth rate and discount rate of company change to constant numbers. Accordingly, only dividends will affect the stock price.

We retrieved the income statements from 1987 to 1992 from Exhibit 2. We adjusted the revenue based on average ounces delivered and average price for gold delivered during year from Exhibit 12. According to case, in the short term, mining firms have a limited ability to adjust production to changes in the price of gold; thus its production decisions were not affected by the market price of gold. Therefore, we safely assume that apart from revenue, other expenses, costs, effective tax rate and payout ratio remain constant. (Appendix I)

Based on our calculation, we estimate that at payout ratio around 22.3%, every 1% change in gold price will lead to around 4.5% change in dividends (Appendix II). Since P=DR-g and we assume that R and g remain constant, the implied stock price should change along with dividends changes. Therefore, every 1% change in gold price will lead to around 4.5% change in its implied stock price. However, the stock price change will not react exactly to what we have estimated. The trend should be the same: gold price increase leads to stock price increase; gold price decrease leads to stock price decrease.

Question 2...