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1. Veteran company is to be taken over by the Sophomore Company at the end of the year 2005.

Sophomore agrees to pay the share holders of Veteran the book value per share at the time of the takeover. A reliable analyst makes the following forecasts for the Veteran. (Assume cost of capital is 12 percent): Particulars (Tk.) 2000 2001 2002 2003 2004 2005 Dividends 1.00 1.00 1.00 1.00 1.00 Operating cash flows 2.00 1.50 1.00 0.75 0.50 Capital expenditure 1.00 1.00 Net income 1.45 1.10 0.60 0.25 (0.10) Book value 9.00 9.45 9.55 9.15 8.40 7.30 Required: a) Estimate the Veteran Company's value per share at the end of the year 2000 using the Dividend Discount Model (DDM). b) Estimate the Veteran company's value per share at the end of the year 2000 using the Residual Income model c) Attempt to estimate the value of the veteran company at the end of the year 2000 using the free cash-flow to equity model. 2. You are the treasurer of ABC Company and is considering investment in some shares of XYZ Company. To make the investment secured you want to determine whether the equity share of the company is undervalued or overvalued. Current market value is Tk. 200 per share. Use the following information about XYZ Company and make a conclusion on the company: (i) Weighted average cost of capital of the company is 12% (ii) Sustainable growth rate is 3.8% (iii) Cash balance in 2008 is Tk.11048 (iv) Interest bearing debt in 2008 is Tk. 18747 (v) Number of shares outstanding is 1000. (vi) Valuation year is 2008. Expected other financial information for the next 5 years are as follows: Amount (TK) particulars 2009 2010 2011 2012 2013 Net Income 4101.0 5144.8 5925.6 7364.2 9260.63 2 2 1 1 Dividend to all common shares 2990.7 3648.2 4449.9 5523.0 6943.87 9 6 7 5 Retention of earnings 1025.2 1286.2 1481.4 1841.0 2315.16 6 1 0 5 Depreciation 6674.8 7342.2 8076.5 8884.1 9772.57 0 8 1 6 Allowance for doubtful accounts 172.08 43.20 52.98 65.17 80.38 Capital expenditure 0.00 0.00 0.00 0.00 0.00 change in working capital 1107.1 1569.7 1983.2 2507.1 3170.00 6 4 3 2

3. Data for Barry computer is given here. Based on the calculated date determine the followings: Balance Sheet Particulars Tk Particulars Tk Cash 77500 Accounts payable 129000 Receivables 336000 Notes Payable 84000 Inventories 241500 Other Current liabilities 117000 Total Current Assets 655000 Total Current liabilities 330000 Net Fixed assets 292500 Long term liabilities 256500 Common equity 361000 Total Assets 947500 Total liabilities & Equity 947500 Particulars Income statement Tk. 717000 453000 68000 113000 41500 Tk. 1607500

Sales Cot of goods sold Materials Labor Heat, light and power Indirect labor Depreciation Gross profit General and administrative Expense Selling expense Earnings Before Interest and Taxes Interest expense Earning After Tax Income Tax Net Income

1392500 215000 30000 115000 70000 24500 45500 18200 27300

Industry norms are given below: (i) Current ratio: 2.5 (ii) Acid test ratio: 1.5 (iii) Inventory turnover: 2.2 times (iv) Average collection period: 90 days. (v) Debt ratio: 0.33 (vi) Times interest earned: 7 (vii) Total assets turnover: 0.75 (viii) Fixed assets turnover: 1.00 (ix) Operating profit margin: 20% (x) Return on Common Equity: 9% Requirement: Calculate the relevant ratios for the firm to compare with the industry norms. Also comment on the following aspects: a) Liquidity of the firm b) Management efficiency and profitability c) Financing techniques of the firm d) Common stockholders receiving return on their investment.

SOLUTION 1. (a) Dividend discount model


1 (1.12)
1

1 (1.12)
2

1 (1.12)
3

1 (1.12)
4

1 (1.12) +
5

7.30 (1.12) 5

= 7.75 Veteran company value per share at the end of 200 is 7.75 using the dividend discount model. (b) Residual income model Particulars Net Income (-) Capital charges Residual income Value
9+ (0.034) (0.546) (0.848) (1.108) 0.37 + + + + (1.12) (1.12) 2 (1.12) 3 (1.12) 4 (1.12) 5

2001 1.45 1.08 0.37

2002 1.10 1.134 (0.034)

2003 0.60 1.146 (0.546)

2004 0.25 1.098 (0.848)

2005 (0.10) 1.008 (1.108)

= 7.75 Veteran companys value per share at the end of year 200 using the Residual income model is 7.75. (c) Free cashflow to Equity model Particulars 2001 Operating cashflow 2.00 (-) Capital expenditure Free cashflow to equity 2.00 Value
2 (1.12)
1

2002 1.50 1.50


(0.25) (1.12)
4

2003 1.00 1.00 0.50 (1.12)


5

2004 0.75 1.00 (0.25)


7.30

2005 0.50 0.50

1.50 (1.12)
2

0 (1.12)
3

(1.12) 5

= 7.25 The value of the Veteran company at the end of year 2000 is 7.25 using free cashflow to equity model.

SOLUTION 2. To take the decision whether I will buy/not XYZ securities depends the intrinsic value of that stock so at first I need to calculate the intrinsic valueParticulars 2009 2010 2011 2012 2013 Net Income 4101.02 5144.82 5925.61 7364.21 9260.63 (+) Depreciation 6674.80 7342.28 8076.51 8884.16 9772.57 (+) Allowance for doubtful accounts 172.08 43.20 52.98 65.17 80.38 Operating cash flow 10,947.9 12530.3 14055 16313 (-) Capital Expenditure (-) Change in working capital 1107.16 1569.74 1983.23 2507.12 3170.00 Free cash flow 9840.74 10960.56 12071 13806 15943 8786 8737 8592 8774 9046 Present value of future free cashflows:
9840.74 10960.56 12071 13806 15943 + + + + 2 3 4 (1.12) (1.12) (1.12) (1.12) (1.12) 5

= 8786 + 8737 + 8592 + 8774 + 9046 = 43935 (2009 2013) Terminal value: In 2013 15943 So, the value = 15943 (1.038) = 16548 Discounting = = 201805

Present value = = 1,14,509 Present value 1,14,509 of terminal value (+) Present value future cash flow (2009-2013) (+) cash balance in 2008 (-) Interest bearing debt Enterprise value 43935 11048 1,69,492 18,747 1,50,745

So, the intrinsic price of XYZ securities

(Enterprise value No. of shares outstanding) = (1,50,745 1000) = 150.75 Conclusion Intrinsic Price < Market Price 150.75 < 200 XYZ Securities is overprised As a treasurer of ABC company I will not invest in XYZ Securities.