NET-Invest is a small investment company. It requires all its analysts to use the dividend discount model (DDM) and the capital asset pricing model (CAPM) to value equity shares. Recently, they have estimated the expected market return of 6.5% per annum. They also think that the risk free rate of interest is 2.5% per annum. Suppose that "Red" and "Blue" are two leading companies in the same industry. Since Red has steady growth in the last ten years, analysts in NET-Invest are relatively confident about the intrinsic value estimation of this company: 2.2 per share, though Red has no cash dividend history. The stock is currently traded at 1.95 per share.

In order to value Blue, analysts have collected the following information: (a)the company has a constant dividend payout policy and the most recent netdividends per share were 0.11. They also estimate the following earnings per share(EPS) growth rates for Blue: First 3 years 8% per year Years thereafter 3% per year Other relevant information includes: the CAPM beta of Blue is 1.3 and Blue is currently traded at 3.2 per share. (c)Would NET-Invest analysts recommend investors to buy, sell or hold Red and Blues shares? Explain your recommendations. (d)Explain the difference between cash dividends and free cash flows to equity holders (FCFE). (e)One analyst argues that the DDM does not apply to Red since it has never paid dividends to shareholders. Comment on this statement.