You recently learned in chapter 7 how to value stocks using the constant dividend growth model (or constant free cash flow growth model) and P/E ratio valuation model. These models show that current stock prices depend heavily on two value drivers, namely, the future growth rate of dividends/cash flows (g) and the firm's expected future cost of capital (rs or K). Remember that P/E ratio can be expressed as dividend payout ratio divided by (k-g). The cost of capital is known as the investors' required return on capital as investors are the capital suppliers and have many investment choices for their capital. (a) If Coronavirus episode is expected to raise the business and financial risks and lower the future earnings of publicly traded small-cap firms and financial firms (e.g., banks), then what will be its effects on the two value drivers and the current market values of small-cap and financial firms? (b) How would a drop in risk-free interest rate brought about by Federal Reserve Bank affect the two value drivers and stock prices of small-cap and financial firms?.

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