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Business
Sector Averages
Revenues (in $ millions)
Enterprise Value/Sales
Computer hardware
Computer services
Country
United States
China
$1,000
$600
0.80
2.00
3.00%
To compute beta
Business
Computer hardware
Computer services
Estimated Value
Weight
$800.00
$1,200.00
$2,000.00
0.4
0.6
To compute ERP
Country
United States
China
ERP
Revenues
5.00%
7.00%
6.00%
9.2400%
Cost of equity in US $ =
$800.00
$800.00
$1,600.00
Part b
First, estimate the divestiture value
Hardware revenues in US =
Estimated value =
Debt raised =
Invested in China services=
Incremental revenue
Business
$500
$400.00
$400.00
$800.00
$400.00 ! Invested value/ EV to Sales of sector
Estimated value
Computer hardware
Computer services
New D/E ratio =
Levered Beta =
To compute ERP
Country
United States
China
Weight
$400.00
$2,000.00
16.67%
83.33%
Revenues
5.00%
7.00%
6.60%
$300.00
$1,200.00
I gave full credit if you weighted the ERP by the values of the businesses in US (600) and C
Cost of equity in US $ =
10.08%
Problem 2
0
Storage facility investment
Inventory investment
Years 1-10
-2,250,000
-750000
Current
Revenues
EBITDA
$5,000,000.00
$900,000.00
After investment
$7,500,000.00
$1,500,000.00
Incremental EBITDA
- Depreciation
Incremental operating income
- Taxes
Incremental after-tax operating income
+ Depreciation
After-tax cash flow
NPV =
$600,000.00
$200,000.00
$400,000.00
$160,000.00
$240,000.00
$200,000.00
$440,000.00
$89,152.82
Part b
With a perpetual life, assume that capital maintenance = depreciation & no salvage value
Initial investment =
-3,000,000
NPV = -3000000 + X/.10 = 0
! No salvage value, if you have perpetual life
Solving for X
Annual after-tax cash flow =
$300,000.00
Incremental after-tax operating income
$300,000.00
Incremental pre-tax operating income
$500,000.00
+ Depreciation
$200,000.00
Breakeven Incremental EBITDA
$700,000.00
Breakeven EBITDA
$1,600,000.00
Breakeven EBITDA margin =
21.33%
Note: Including depreciation while ignoring capital maintenance is not an option, since de
Problem 3
Current beta =
Current cost of equity =
Current after-tax cost of debt =
Debt ratio =
Cost of capital =
New Debt/Equity ratio =
Unlevered beta =
New levered beta =
New cost of equity =
New after-tax cost of debt =
New debt ratio =
New cost of capital =
Old firm value =
Increase in firm value
New firm value =
- New Debt =
New equity value =
No of shares
Value per share =
3.06
18.300%
6%
80%
8.4600%
1.5
0.9
1.71
11.5500%
4.50%
0.6
7.32%
1000
214.2857142857
1214.2857142857
600 ! Don't forget to subtract debt
614.2857142857
40 ! Divide by total # shares
$15.36
(You will get the same answer, if you divide the increase in value by total number the shar
Problem 4
Revenues
Net Income
Depreciation
Cap Ex
$1,000
$100
$40
$50
$1,100
$110
$45
$60
$10
$10
$30
$15
0%
40%
Next year
$110.00
$45.00
$60.00
$20.00
$5.00
$80.00
$44.00
$36.00
$126.00
Year +2
Revenues
Net Income
+ Depreciation
- Cap Ex
- Change in Working capital
- Debt repaid
FCFE
Dividends paid
Change in cash balance
Cash balance
$1,440.00
$144.00
55
77
$84.00
$25
$13.00
$72.00
-$59.00
$137.00
$1,728.00
$172.80
60.5
84.7
$28.80
$25
$94.80
86.4
$8.40
$145.40
Problem 5
After-tax operating income =
Invested capital =
Return on capital =
60
500
12%
High Growth
1
After-tax operating income
- Reinvestment
FCFF
Terminal value
Present value
Value of operating assets =
+ Cash
- Debt
Value of equity
Value per share =
Price per share =
Undervalued by
Stable growth
9.00%
75.00%
3%
25.00%
2
$65.40
$49.05
$16.35
$71.29
$53.46
$17.82
$14.86
$688.43
$50.00
$300.00
$438.43
$17.54
$16.00
-8.766%
$14.73
Sector Averages
Unlevered Beta
Grading template
1.25
0.9
Total Revenues
$800.00
$800.00
1. Wrong risk free rate: -1/2 point
Unlevered Beta
1.25
0.9
1.04
Weights
0.5
0.5
1.
2.
3.
4.
Unlevered Beta
1.25
0.9
0.9583
Salvage Value
250000
750000
Incremental
$2,500,000.00
$600,000.00
1.
2.
3.
4.
5.
s not an option, since depreciation will run out after ten years.
t to subtract debt
1.
2.
3.
4.
1.
2.
3.
4.
otal # shares
by total number the shares and add to the value per share)
$60
$75
50%
Most recent year
$120.00
$50.00
$70.00
$30.00
$60.00
$130.00
$60.00
$70.00
$196.00
Year +3
$2,073.60
$207.36
66.55
93.17
34.56
$25
$121.18
103.68
$17.50
$162.90
1.
2.
3.
4.
5.
Terminal year
$77.70
$58.28
$19.43
$857.49
$658.84
$80.03
$20.01
$60.02
1.
2.
3.
4.
Problem 1
US
Steel
Technology
Total
Grading template
Brazil
Total
$800.00
$400.00
$1,200.00
$600.00
$300.00
$900.00
$1,400.00
$700.00
Part a
For beta
Steel
Technology
Value
Weight
Unlevered beta
$1,800.00
57.14%
0.9
$1,350.00
42.86%
1.2
$3,150.00
1.02857
For ERP
US
Brazil
Weight
$2,100.00
$1,050.00
$3,150.00
Cost of equity
ERP
66.67%
33.33%
6%
9%
7.00%
Part b
US
Steel
Technology
Total
$1,200.00
$900.00
$2,100.00
Brazil
Total
$600.00
$1,800.00
$1,200.00
$2,100.00
$1,800.00
2700
44.44%
For beta
Value
Weight
Unlevered beta
$1,800.00
46.15%
0.9
$2,100.00
53.85%
1.2
$3,900.00
1.06154
New levered b 1.344615385
Steel
Technology
For ERP
US
Brazil
Value
Weight
ERP
$2,100.00
53.85%
$1,800.00
46.15%
$3,900.00
Cost of equity
After-tax cost
Debt ratio =
Cost of capita
12.93%
3.00%
30.77%
9.87%
Problem 2
Part a
Initial invest
Annual cash flow
-$5,000.00
1200
Equity =
D/E ratio =
1.
2.
3.
4.
5.
6%
9%
7.38%
Revenue
EBITDA
- DA
EBIT
- Taxes
Aftertax EBIT
+ DA
After-tax Cash
NPV =
$4,000.00
$800.00
$500.00
$300.00
$120.00
$180.00
$500.00
$680.00
1.
2.
3.
4.
-$635.99
Part b
Annual after-t
Revenues=
$107.99
$539.96 ! Divide by after-tax margin
Part c
Existing
Expensed
$0.00
Tax savin
$0.00
New
$2,000.00
Depreciation
$500.00
$800.00
$600.00
Depreciation t
$200.00
$240.00
10.00
5.00
PV of tax savi
$1,283.53
$933.52
Change in NP
$449.98
$250.00
1. All or nothing
Number of yea
Problem 3
Part a
Expected FCFF
$5,000.00
8.40%
Cost of equity
Value of the f
3.400%
Part b
New Debt$2,000.00
New Equit$3,000.00
66.67%
New D/E ratio
40.00%
New D/C ratio
1.26
New levered b
Cost of equity 10.5600%
7.0000%
Cost of debt
8.02%
Cost of capital
$415.94
Change in fir
Part c
If the cash is paid out a as a special dividend, the number of shares remains unchanged at 80 million
$5,415.94
$2,000.00
- Debt
New Equity va $3,415.94
New firm valu
All or nothing
$34.16
Part c
$5,415.94
$2,000.00
- Debt
Value of equit $3,415.94
New firm valu
If buyback price =
33.02069528
Number of sha2000/X
Remaining shares
Remaining sha100-2000/X Price per share =
Value to buyb (X-50)*(2000/X)
(100 -2000/X)*51= 3415.94 Value of equity=
66.97930472
51
$3,415.94
Solving for X
X=
$60.57
Problem 4
1
12%
30%
2
14%
25%
3
16%
15%
Revenues
$100.00
Net Income
$10.00
Capital expend
$40.00
Depreciation
$12.00
Non-cash Work
$36.00
Chg in noncash WC
FCFE
Cash balance
$45.00
1
$140.00
$16.80
$46.00
$15.00
$42.00
$6.00
-$20.20
$24.80
2
$196.00
$27.44
$52.90
$18.75
$49.00
$7.00
-$13.71
$11.09
3
$274.40
$43.90
$60.84
$23.44
$41.16
-$7.84
$14.35
$25.44
Revenues
$100.00
$140.00
Net Income
$10.00
$16.80
Capital expend
$40.00
$46.00
Depreciation
$12.00
$15.00
Non-cash Work
$36.00
$42.00
Chg in noncash WC
$6.00
New Debt
$4.00
FCFE
-$16.20
- Dividends paid
$3.36
Cash balance
$45.00
$25.44
Desired cash balance at end of year 3
Cash available for buybacks
$196.00
$27.44
$52.90
$18.75
$49.00
$7.00
$4.00
-$9.71
$5.49
$10.24
Net Margin
Total non-cas
Part a
Part b
Problem 5
After-tax oper
10
12.00%
Book value of
45
Book value of
15
Cash
10
Invested capit
50
Return on capi
20%
10%
Net Cap ex
Change in non
Normalized acq
Reinvestment
Expected grow
Expecedd grow
Reinvestment r
After-tax oper
Reinvestment
FCFF
Terminal value
PV @ 12.5%
Value of opera
$2.00
$1.00
$3.00
60%
12.00%
3.0%
15.00%
1
$11.20
$6.72
$4.48
2
$12.54
$7.53
$5.02
$4.00
$137.07
$4.00
+ Cash
$10.00
- Debt
$15.00
Value of equit
Value per sha
Terminal value
1. Did not recompute reinvestment rate: -1/2 po
2. Used wrong discount rate: -1/2 point
3. Math errors: -1/2 point each
$132.07
$26.41
Value today
1. Used wrong discount rate: -1/2 point
2. Used wrong discount rate just on terminal va
3 Term year
3. Cash not added: -1/2 point
$14.05
$14.47 4. Debt not subtracted out: -1/2 point
$8.43
$2.17
$5.62
$12.30
$175.72
! New reinvestment rate = 3%/20% = 15%
$129.07
ed incorrectly: -1 point
incorrectly: -1 point
wrong: -1 point
eighted for business: -1 point
eighted for country: -1 point
er beta: -1 point
beta: -1 point
at 80 million
Problem 1
Part a.
Business
Estimated Val Weight
Storage Devic
400
Electronics
600
Social Media
800
Firm
1800
Equity
1200
Debt
600
D/E ratio =
0.5
Levered beta =
0.2
0.4
0.8
Unlevered beta
0.9
1.2
1.8
1.4
1.82
Part b
Business
Estimated Val Weight
Unlevered Beta
Electronics
600
0.375
1.2
Social Media
1000
0.625
1.8
Firm
1600
1.575
Equity
1200
Debt
400
D/E ratio
0.333333333
Levered beta =
1.89
Part c
Business
Estimated Val Weights
Unlevered beta
Electronics
600 0.428571429
1.2
Social Media
800 0.571428571
1.8
Firm
1400
1.542857143
Equity
800
Debt
600
D/E
0.75
Levered Beta =
2.24
Problem 2
0
-20
5
0
Incremental Revenue
Incremental EBITDA
Incremental Depreciation
Incremental EBIT
Incremental Tax
Incremental EBIT (1-t)
+ Incremental Depreciaton
- Incremental
-10
FCFF
-10
NPV =
-$0.32
$10.00
$2.00
4
-$2.00
-$0.80
-$1.20
4
$0.50
$2.30
$20.50
$4.10
4
$0.10
$0.04
$0.06
4
$0.53
$3.54
$31.53
$6.31
4
$2.31
$0.92
$1.38
4
$0.55
$4.83
$43.10
$8.62
4
$4.62
$1.85
$2.77
4
$0.58
$6.19
$55.26
$11.05
4
$7.05
$2.82
$4.23
4
$13.37
-$5.14
200
$210.00
$10.00
200
$220.50
$20.50
200
$231.53
$31.53
200
$243.10
$43.10
200
$255.26
$55.26
$10.50
$0.50
$11.03
$0.53
$11.58
$0.55
$12.16
$0.58
$25.53
$13.37
Investment
Revenue befor
Revenue after
Incremental revenue
Working capita
Working capita
Incremental
200
20
10
10
b. Effect of expensing
Tax benefit of
$8.00
Tax benefit of
Effect on NPV
New NPV =
c.
NPV with syst
Cost of syste
NPV of increm
Annual after-t
Pre-tax expen
-$0.32
-$13.93
$13.62
$3.59 ! Annuity given NPV
$5.99 ! Pre-tax amount
Long way to do
0
Incremental EBITDA
Incremental EBIT
Incremental taxes
Incremental EBIT (1-t)
- Incremental
-$10.00
FCFF
$10.00
PV
$13.62
1
$2.00
$2.00
$0.80
$1.20
$0.50
$0.70
2
$4.10
$4.10
$1.64
$2.46
$0.53
$1.94
3
$6.31
$6.31
$2.52
$3.78
$0.55
$3.23
4
$8.62
$8.62
$3.45
$5.17
$0.58
$4.59
5
$11.05
$11.05
$4.42
$6.63
$13.37
-$6.74
Problem 3
Part a
Current lever
Cost of equity
After-tax cost
Market value o
Debt
Debt ratio =
Cost of capita
Unlevered bet
New D/E ratio
Levered beta
Cost of equity
After-tax cost
Debt ratio =
Cost of capita
Change in cost
Savings each
Increase in fi
New firm valu
New debt (to
Old debt
Increase in de
1.15
9.900%
2.40%
800
200
0.2
8.40%
1
9
6.4
41.400%
4.50%
90%
8.1900%
0.2100%
2.1
$25.64
$1,025.64
$923.08
$200.00
$723.08
Problem 4
Last12months
Revenues
$1,000
EBITDA
$250
Depreciation
$60
NetIncome
$80
NoncashWorki
$75
TotalDebtouts
150
Parta
FCFEwihtoutc
NetIncome
+ Depreciatio
$88
$66
($5)
-5
$154
$52.80
Changeinn
+(NewDebt
FCFE(beforeca
Dividends
Changeincashbalance
Capitalexpenditures
1
$1,100
$275
$66
$88
$70
145
2
$1,200
$300
$72
$96
$65
140
3
$1,300
$325
$78
$104
$60
135
$96
$72
($5)
-5
$168
$57.60
$104
$78
($5)
-5
$182
$62.40
$112
$84
($10)
-5
$201
$67.20
4
$1,400
$350
$84
$112
$50
130
5
$1,500
$375
$90
$120
$40
125
5 Cumulative
$120
$90
($10)
-5
$215
$72.00
$520
$390
($35)
($25)
$920
$312
-100
$708
Partb,
Tokeepthecashbalanceconstant&paydowndebt
$312 ! You don't need cap ex to solve this part of the problem
Exisitngdivide
125 ! So, not credit for carry through of part a mistakes
Cashtopay
100
Cashflowto
$87
Remainingdivi
$520
Cumularivenet
Payout ratio
16.73%
Partc
Thecompanyexpectsitsearningsgrowthandreinvestmentneedstodecreaseinthefuture
Problem 5
Current
After year 5
EBIT (1-t)
10
Invested Capit
100
Net Cap Ex
7
Change in work
2
Return on capi
10%
10%
Reinvestment
90%
30%
Expected grow
9%
3%
Cost of capital
12%
8%
Year
1
2
EBIT (1-t)
$10.90
$11.88
- Reinvestme
$9.81
$10.69
FCFF
$1.09
$1.19
Terminal value
Present value
$0.97
$0.95
Value of opera
$130.51
+ Cash
$15.00
- Debt
$40.00
Value of equit
$105.51
/ Number of s
$8.00
3
$12.95
$11.66
$1.30
4
$14.12
$12.70
$1.41
$0.92
$0.90
5 Terminal year
$15.39
$15.85
$13.85
$4.75
$1.54
$11.09
$221.87
$126.77
$13.19
!
!
!
!
! Did not compute lost PV from depreciation tax savings correctly: - 0.5 points
(If you did the entire problem the long way - with the cash flows - you should
get the same effect where your NPV increases by this amount)
! Used NPV from part 1 without correcting for investment & depreciation: -1 point
! Did not annualize: -1 point
! All of the other reasons may sound plausible, but they are not defensible. You don't want
to pay dividends just because everyone else is or to attract dividend-liking investors just
for the sake of expanding your investor base. You certainly don't want to pay dividends
if you expect your reinvestment needs to be high in the future.
pay dividends
Problem 1
a.
Market value of equity =
800
Market value of interest bearing d
400
PV of lease commitments =
406.0553654 ! PV of $ 80 million @5%
Firm value =
1606.055365
Debt ratio =
50.19%
Beta =
1.15
Cost of equity =
9.25%
Cost of debt (after-tax)
3.00%
Cost of capital =
6.11%
b.
Value of entertainment =
963.6332192
Value of electronics =
642.4221462
Current unlevered beta =
0.716715637 ! 1.15/(1+(1-.4)(806/800))
Unlevered beta = 0.7167 = 0.90 (.4) + X (.6)
Solving for new unlevered beta
Unlevered beta after divestiture = 0.594526061
Debt after transaction =
645.4498288 ! 806 - 0.25*642.42
Equity after transaction =
318.1833904 ! 800 - 0.75*642.42
D/E ratio after transaction =
2.028546581
Levered beta after transaction = 1.318140347
Cost of equity =
10.09%
After-tax cost of debt =
3.90%
Cost of capital =
5.94%
1.
2.
3.
4.
1.
2.
3.
4.
5.
Did
Did
Did
Did
Did
1.
2.
3.
4.
5.
not
not
not
not
not
Problem 2
Initial investment =
Initial investment in WC =
60
10
0 Yrs 1-10
-70
Initial investment
Salvage
Revenues
EBITDA
- Depreciation
EBIT
EBIT (1-t)
+ Depreciaton
Cash flow
NPV =
20
100
15
5
10
6
5
11
9.042450851
Year 10
-70 Forever
c.
PV of synergy =
Problem 3
a.
Current cost of equity =
After-tax cost of debt =
Debt ratio
Cost of capital
0.085
0.027
0.2
0.0734
b.
New debt ratio =
Unlevered beta =
New levered beta =
Cost of equity =
After-tax cost of debt =
Cost of capital =
0.6
0.869565217 ! 1/(1+(1-.4)(0.25))
1.652173913 ! 0.8686(1+(1-.4)(1.50))
0.117608696
0.039
0.070443478
c.
Increase in firm value =
52.46265893 ! (.0734-.0704)(1250)/.0704
1.
2.
3.
4.
!
!
!
!
Problem 4
Revenues
Net income
+ Depreciation
- Cap Ex
- Change in WC
- (Debt repaid + Debt issued)
FCFE
Dividends
Change in cash balance
Cash balance at start of year
Cash balance at end of year
Total reinvestment =
Debt used =
Debt ratio =
2
1
0.5
Payout ratio =
c.
iii.NegativeJensensalpha,negativeEVA
I would not trust the managers of the company and want my cash back.
Part a
1. Error on dealing with change in working
2. Error on dealing with change in debt: -0
3. Other errors in computing FCFE: -0.5 po
4. Change in cash balance incorrect: -0.5 p
Part b
1. Did not compute change in working cap
2. Did not compute change in debt correct
3. Other errors: -0.5 point each
4. Divided dividend by revenues or some o
Problem 5
High growth
Return on capital =
Expected growth =
Reinvestment rate =
Cost of capital
Year
EBIT (1-t)
Reinvestment
FCFF
Terminal value
Present value (at 12%)
Value of operating assets =
+ Cash
- Debt
Value of equity
Value per share
25.00%
10%
0.4
12%
Current
$20.00
Stable growth
15% Return on capital = EBIT
3%
0.2 ! g/ ROC
10%
1
2
3
$22.00
$24.20
$26.62
$8.80
$9.68
$10.65
$13.20
$14.52
$15.97
$11.79
272.0068328
20
50
242.0068328
$12.10
$11.58
$11.37
4
$29.28
$11.71
$17.57
$11.17
not to salvage working capital, you have to show the tax benefit
ear 10 because you will be writing off the investment. That
be 0.4(10) = 4
t beta: -1 point
vering and relevering beta: - 0.5 point
ax cost of debt: -0.5 point
tax cost of debt: -0.5 point
Part b
a. Did not compute reinvestment: -1 point
b. Did not use new cost of capital;: -0.5 point
c. Other errors in computation: -0.5 point
Part c
a. Used wrong discount rate for term value: -0.5
b. Did not compute PV of FCFF: -0.5 point
c. Forgot to add cash: -0.5 point
d. Forgot to subtract debt: -0.5 point
Problem 1
Book Value
$500
$500
$1,000
Cement
Steel
Total
a,
Market value of equity =
Market value of debt =
Debt/equity ratio =
Unlevered beta for firm =
Levered beta for firm =
Cost of equity =
After-tax cost of debt =
Debt Ratio =
Cost of capital =
b
Cement
Steel
$1,000
! Used book value weights for unlevered beta: -0.5 point
$500
! Debt to equity ratio set to zero or ignored: -1 point
50.00%
! Did not use after-tax cost of debt: -0.5 point
! Math errors: -0.5 point
1.02
1.33 Computational notes
10.63%
The unlevered betas should always be weighted based upon the market value
3.60%
Since balance sheets have to balance, the market value of assets (businesses
33.33%
Thus even though the debt is not given, it can be backed out of the market va
8.29%
ROC
15.00%
5.00%
Problem 2
Life Products
Pfizer
$750.00
90.00
$50.00
$140.00
Discount rate =
PV of cash flows =
NPV =
b. PV of licensing fees has to be greater than the NPV of investing and ! Used wrong discount rate: -1 point
PV of cash flows =
$178.61
! PV formula not set up: -1 pont
Annual after-tax cash flow
$17.21
! Use pre-tax cost of debt fo (I gave full credit for both 15-year annuity and pe
Annual licensing fee =
$28.68
! Tax rate implicit in pre-tax and after-tax cost of debt. No points off for not do
Problem 3
10.00%
Current cost of equity =
3.60%
Current after-tax cost of
$2,000.00
Current firm value =
25.00%
Debt Ratio =
8.40%
Current cost of capital =
8.00%
New cost of capital=
0.40%
Savings in cost of capital
$100.00
PV of savings =
Part a: Buy back stock at $10.25
48.78
# of shares bought back
Compuatational notes
The key part of this problem is recognizing that when investors
and those who do not will be a function of the buyback price. W
a buyback price is provides is an indication that they are not. A
Thus, you need to go through the following steps:
1. Estimate the change in firm value from the change in the co
2. Estimate how many shares you will buy back at the buyback
3. Estimate how much buyback stockholders get of the value c
4. Estimate how much remaining value change there is for thos
5. Divide by the remaining shares outstanding to get the value
Premium paid =
Value paid to buyback sh
Remaining value increas
Remaining shares =
increase in value for rem
Value per share =
$0.25
$12.20
$87.80
101.22
$0.87
$10.87
-3
$1,000
$100
$25
$100
-2
$1,200
$120
$40
$90
Last year
$1,500
$150
$50
$75
$120
$40
-$10
$170
$150
$50
-$15
$215
$48.0
$60.0
$385
128
$257.00
Next year
Revenues
$1,725.0
Net Income
$172.5
Cap Ex
$86.25
Depreciation
$57.5
Chg Non cash Working Capit
11.25
New Debt issued
10.00
FCFE
$142.50
Dividends
$69.0
!
!
!
!
Problem 5
Loans
Current
$5,000.00
1
$5,500.00
2
$6,050.00
3
$6,655.00
4
$7,320.50
$400.00
8.00%
$451.00
8.20%
$51.00
$508.20
8.40%
$57.20
$572.33
8.60%
$64.13
$644.20
8.80%
$71.87
Net income
- Capital invested
FCFE
$100.00
$110.00
$51.00
$59.00
$121.00
$57.20
$63.80
$133.10
$64.13
$68.97
$146.41
$71.87
$74.54
b. Stable growth
ROE =
Expected growth rate =
Equity Reinvestment Rate
Net income in year 6 =
FCFE in year 6=
Cost og equity ;in year 6 =
Terminal value of equity in
c. Value today
Year
FCFE
Terminal value of equity
PV
Value of Equity
/ number of shares
Value per share
12.00%
4.00%
33.33%
$167.49 ! 161.05*1.04
$111.66
10.00%
$1,861.03
1
$59.00
2
$63.80
3
$68.97
4
$74.54
$52.68
$1,301.69
50
$26.03
$50.86
$49.09
$47.37
5
$80.53
$1,861.03
$1,101.69
ted based upon the market values of the businesses, not book values
arket value of assets (businesses) = market value of equity + debt
n be backed out of the market value of the assets
Cost of capitalEVA
7.77%
9.07%
$36.17
-$20.33
Computational notes
The key aspect of the licensing fee is that it is a fixed amount
and that the only risk you face is the default risk in Pfizer. Since it is a fixed amount (anld
not a function of operating income or risk), the discount rate is the pre-tax cost of debt
for Pfizer. It is not the cost of capital.
If the licensing fee had been a percentage of operating income on the product, it would have
been appropriate to use Pfizer's cost of capital to discount the cash flows.
Com
recognizing that when investors are not rational, the value allocation between those who sell back shares
function of the buyback price. While the problem does not specify that investors are not rational, the very fact that
an indication that they are not. After all, when investors are rational, the buyback price = price for the remainign shares.
the following steps:
value from the change in the cost of capital (as you always do)
you will buy back at the buyback price (Dollar debt taken/ Buyback price)
k stockholders get of the value change (Buyback price - Original price) (No of shares bought back)
ng value change there is for those who do not sell back their shares
res outstanding to get the value change for remaining stockholders
5
$8,052.55
Compuational notes
For a bank, investment in regulatory capital becomes the equivalent of net cap ex and wor
$724.73
9.00%
$80.53
capital change. Thus, the amount you have to invest in regulatory capital has to be taken o
of net income each year to get to FCFE. I gave full credit, if you estimated the investment i
regulatory capital to be an absolute number ($64.95 million a year)
$161.05
$80.53
$80.53
r 6 correctly: -1 point
alue: -1 point
sses (used company cost of capital): -2 points
Problem 1
Levered Beta
Tax rate
Market value of equity
Book value of equity
Market & Book value of debt
a. Unlevered beta
Value of the firm =
Weights of the firms =
Unlevered beta for the firm =
b.
Levered beta after transaction =
To compute D/E ratio
1.05 ( 1+ (1-.4)* D/E) = 1.35
Solving for the D/E ratio
Debt to equity =
Value of combined firm =
Debt in combined firm =
Debt in existing firms =
New debt for deal =
c.
Cost of equity =
Cost of debt =
Debt ratio =
Cost of capital =
Trident (acquirer)
1.2
40%
12000
8000
3000
Achilles
(Target)
1.5
40%
6000
8000
4000
1.043478261 1.071428571
15000
10000
60.00%
40.00%
1.05
1.35
46.67%
$25,000.00
$7,955.23
$3,000.00
$4,955.23
12.100%
3.300%
31.821%
9.30%
Problem 2
a. Correct discount rate is cost of capital (since operating cashflows are being discounted)
Cost of capital =
8.80%
b. Computed NPV =
Discount rate used =
Initail investment =
PV of 10 years of earnings =
Annual after-tax OI =
c.
Assets
Non-cash WC
20
12%
600
620
$109.73 ! Annuity given r=12% and 10 years
Initail investm Salvage
600
50
0
50
EBIT (1-t)
+ Depreciation
- Change in WC
FCFF
$109.73
60
0
$169.73
NPV =
Problem 3
a. Current debt ratio =
Cost of equity =
Cost of capital =
b. Implied growth rate
Current value of firm =
Expected cash flow next year=
Value of firm = 1500 = 80/ (Cost of capital -g)
Solve for g,
Implied growth rate =
c. New cost of capital =
Annual savings =
PV of savings with implied growth =
Debt at the optimal debt ratio
Existing debt =
New Debt issued =
# Shares bought back =
Preimium to shares bought back =
Remaining premijm =
Remaining number of shares =
Increase in value per share =
0.2
0.094
8.24%
1500
80
d. Only if new investments earn more than the new cost of capital. After you borrow the money,
the new cost of capital is the only one you care about.
Problem 4
Revenues =
Net Income =
Depreciation =
Cap Ex =
Non-cash Working capital =
Expected growth rate =
Debt ratio for funding new investments
Year
Revenues
Non-cash Working capital
Net Income
+ Depreciation
- Cap ex
- Change in WC
+ New debt issued
FCFE
Total FCFE =
Dividends to be paid =
Total Net income =
Payout ratio -=
100
25
10
15
12
20%
25%
1
120
14.4
30
12
18
2.4
2.1
23.7
86.268
76.268
109.2
69.84%
2
144
17.28
36
14.4
21.6
2.88
2.52
28.44
3
172.8
20.736
43.2
17.28
25.92
3.456
3.024
34.128
36
14.4
21.6
2.88
10
15.92
43.2
17.28
25.92
3.456
10
21.104
0
48.624
44.53%
c. Firms are less certain about future earnings (buybacks are flexible)
The other answers either do not make sense (more certain about earnings would increase dividends
or would have applied even more strongly prior to the last decade (dividends taxed at a higher rate
(I know we talked about mgmt compensation containing options, but more as a contributing factor
than the main factor. If you did circle other, and mentioned this, you did get 0.5 point)
Problem 5
EBIT (1-t)
- Net Cap Ex
- Chg in non-cash WC
FCFF
Book Capital invested =
Reinvestment rate =
Return on capital =
Expected growth rate =
a. FCFF for next 3 years
Year
EBIT (1-t)
- Net Cap Ex
- Chg in WC
FCFF
PV (at 12%)
b. Terminal value
Growth rate =
Return on capital =
Reinvestment rate =
EBIT (1-t) in year 4 =
- Reinvestment in year 4 =
FCFF in year 4
Terminal value =
4000
1000
200
2800
12000
30.00%
33.33%
10.00%
3%
33.33%
9.00%
$5,483.72
$493.53
$4,990.19
$71,288.36 ! Use stable period cost of capital
$8,103.56
$50,741.65 ! Discount at 12% for 3 years
$58,845.20
$4,000.00
$54,845.20
$10.97
1
$4,400.00
$1,100.00
$220.00
$3,080.00
$2,750.00
2
$4,840.00
$1,210.00
$242.00
$3,388.00
$2,700.89
3
$5,324.00
$1,331.00
$266.20
$3,726.80
$2,652.66
8.8%,10) + 50/1.088^10
! Forgot the tax effect: -0.5
! Multipled by (1-t) instead of t: -0.5 point
!
!
!
!
Problem 1
a. Unlevered Beta =
b. Debt =
Equitty =
D/ E Ratio =
Levered Beta =
c. New unlevered beta =
New Debt =
New Equity =
D/E Ratio =
New levered beta =
Grading Guidelines
1.04
500
2000 ! Value of the firm - Debt
0.25
1.196
1
1500
1500
1
1.6
1.
1.
2.
3.
Problem 2
Investment in upgrade =
- Salvage of old plant
Initial investment
10
1. Computed PV of future cash flow
2.5 ! Depreciation of $500,000 for next 5 years2. I have no clue what you were doi
7.5
Problem 3
a. Cost of equity today =
9.400%
Cost of debt today =
3.00%
Debt Ratio =
0.2
Cost of capital today -=
8.12%
b. Unlevered beta =
1.043478261
New levered beta =
1.460869565
New cost of equity =
10.57%
New cost of debt =
0.036
New debt ratio =
0.4
Cost of capital =
7.78%
c. Annual savings =
3.356521739 ! (.0812-.0778) (1000)
PV of savings =
88.69485294 ! 3.36/(.0778-.04)
Increase in value/share 1.108685662 ! Divide by 80 million
New share price =
11.10868566
Amount of buyback =
200
# of shares bought back 18.00393009
1.
2.
3.
4.
Problem 4
Year
Revenues
Net Income
Deprecistion
Dividends paid
Decrease in cash balance
FCFE over 3-year period =
Net Reinvestment
Gross Reinvestiment
-3
1000
100
50
40
-2
1200
120
60
48
-1 Total
1500
150
75
60
3700
370
185
148
40
108
262 ! Net Income - Dividends + Chg in Cash
447 ! Add depreciation
Revenues
Net Income
Depreciation
Capital Expenditures
Change in working capital
Dvidends
Total dividends =
Increase in cash balance
Required FCFE =
Net Reinvestment
Total Reinvestment
Debt used =
As % of Reinvestment =
1
1650
165
82.5
165
37.5
66
2 Total
1815
3465
181.5
346.5
90.75
173.25
181.5
346.5
41.25
78.75
72.6
138.6
138.6
40
178.6
167.9
252
84.1
33.37%
Problem 5
Year
EBIT(1-t)
FCFF
Reinvestment Rate =
Expected growth rate=
Return on capittal =
Current
$80.00
$20.00
75.00%
15.00%
20.0%
1
$92.00
$23.00
2
$105.80
$26.45
3
$121.67
$30.42
2
$26.45
3
$30.42
1405.964444
$21.09
$1,022.39
1.
2.
3.
4.
5.
rading Guidelines
Error on weighting or used levered betas: -0.5 each
Used book value of equity: -1
Used effective tax rate: -.5
Math error: -0.5
Did not estimate higher cashflows from years 6-10: -1 to 1.5 points
Ignored years 6-10 completely: -1.5 point
Ignored initial investment: -1 point
Weights on debt and equity wrong: -0.5 point
Wrong cost of equity: -0.5 point
Forgot after-tax cost of debt: -0.5 point
Did not recompute beta: -1 point
Errors on weights: -0.5 to -1 point
Forgot to after-tax cost of debt: -0.5 point
1
gave full credit for both net and gross reinvestment
Forgot cash balance change: -1 point
Subtracted change in cash baqlance: -1 point
ny mistake in this problem cost you a point, even if it were a math error
mply because tracing out math errors was very messy.
you got the dollar debt used (84.1) correct, you got
ll credit even if your ratio did not match up.
Problem 1
a. Market value of equity =
Debt value =
Debt to equity ratio =
200
50
0.25
Firm value =
Cash =
Operating ass
250
25
225
1.2
b. New debt =
Equity =
New Debt/Equity ratio =
350
225
125
Problem 2
a. NPV of project =
PV of cashflows over next 5 years =
Annual after-tax cashflow =
Annual after-tax operating income =
-1.2
8.8 ! Initial investment + NPV
$2.32 ! Five year annuity with r=10%
$0.32 ! Subtract out depreciation of $ 2 million
b. PV of tax benefits
From straight line depreciation =
From accelerated depreciation =
Tax benefit
PV
$1.60
$1.20
$0.60
$0.40
$0.20
$1.45
$0.99
$0.45
$0.27
$0.12
$3.29
$0.26 ! Difference in present values
6.00% ! After-tax operating income/ BV of capital
10.00%
-16
Problem 3
a. Current cost of equity =
Cost of capital =
b. New Debt to Equity =
New beta =
New cost of equity =
New cost of capital =
Change in firm value =
Change in value per share =
c.
Debt to Equity =
New beta =
New cost of equity =
New cost of capital =
Change in firm value =
NPV from project =
Total increase in firm value =
Increase in value per share =
9.80%
9.80%
33.33%
1.44
10.76%
9.12%
$11.11
$2.78
0.25
1.38
10.52000%
9.26%
8.695652174
$5.00
$13.70
$3.42
Problem 4
Year
NetIncome
NetCapex
ChangeinnoncashWC
+Changeindebt
FCFE
Change in cash balance over 3
years=
TotalFCFEover3years=
30
$245.00
Totaldividendspaidover3years=
Dividendpayoutratio=
b.ExpectedFCFEnextyear
$110.00
Cashavailableforstockholders=
$110.00
58.11%
Problem5
EBIT (1-t)
- Net Cap Ex
- Change in non-cash WC
FCFF
PV (at current cost of capital of 12%)
Current
$20.00
$10.00
$5.00
$5.00
1
$23.00
$11.50
$5.75
$5.75
$5.13
2
$26.45
$13.23
$6.61
$6.61
$5.27
3
$30.42
$15.21
$7.60
$7.60
$5.41
75%
15%
20.0%
0.04
0.2
$31.63
$25.31
$421.79
n; Equity decreases
00)/(.0912-.03)
n; Equity does not change a. Did not compute new debt ratio and cost of capital: -1 point
NPV will add to equity valub. Did not add back NPV of new invstment: -1 point
00)/(.0926-.03); note that even though firm value increases to 125, you save only on the old firm value which was invested at the old
a. Reduced FCFE by cash balance (this will double the cash balance): -0.5 to 1 point
b. change in WC incorrect: -1 point
c. Other error: -0.5 to -1 point
Problem 1
Part a
Market value of equity =
Market value of debt =
Unlevered beta =
Levered beta =
Cost of equity =
Cost of capital =
700
300
0.96
1.206857143
0.093274286
7.43%
Part b
New business mix after acquisition
Hotels
Transportation
New value for Equity =
New value for debt =
Unlevered beta=
New debt to equity ratio =
Levered beta =
New cost of equity =
Cost of capital =
1000
400
800
600
0.914285714
0.75
1.325714286
0.098028571
7.02%
Problem 2
Iniital investment =
Reduction in Inventory =
Savings from storage facility
Net Initial Investment =
Annual Cash flow
Increased Revenue
Increase in EBIT
- Depreciation
Increase in EBIT
Increase in EBIT (1-t)
+ Depreciation
- Change in WC
Annual Incr CF
NPV =
-15
4
4 ! Investment in new facility - Capital Gains tax - Investment in old facilit
-7
Yr 1
yrs 2-10
15
1.8
1.5
0.3
0.18
1.5
1.2
0.48
15
1.8
1.5 ( No incremental depreciation from storage facility, since
0.3 the old and the new system have same book value)
0.18
1.5
1.68
$2.23
Problem 3
Cost of equity Cost of debt (after-tax)
Market value of equity =
Market value of debt
Cost of capital =
0.1074
0.03
150
46.13913254 ! You have to compute market value based upon interest expenses and
8.92%
Part b
Unlevered beta =
New market value of equity =
New market value of debt =
New levered beta =
New cost of equity =
New cost of debt =
Cost of capital =
1.316948546
100
96.13913254 ! I did give full credit if you assumed that refinancing would alter market
2.076610291
0.128064412
0.042
8.59%
$11.63
$4.65
$3.49 ! Don't forget to net out the share of the surplus given to those who sel
$8.14
$10.35
$0.79
$10.79
Problem 4
Year
Revenues
Non-cash WC
Net Income
+ Depreciation
- Cap ex
- Change in non-cash WC
FCFE
Dividends paid
Cash balance
$50.00
$10.00
$15.00
$10.00
$16.00
$15.00
1
$55.00
$11.00
2
$60.50
$12.10
3
$66.55
$13.31
4
$73.21
$14.64
$16.80
$11.00
$17.60
$1.00
$9.20
$8.40
$15.80
$18.82
$12.10
$19.36
$1.10
$10.46
$9.41
$16.85
$21.07
$13.31
$21.30
$1.21
$11.88
$10.54
$18.19
$23.60
$14.64
$23.43
$1.33
$13.49
$11.80
$19.87
b. To maintain its cash balance at $ 15 million, the firm can afford to pay out $ 4.87 million more in dividends over the e
Total dividends paid =
$45.02
! No need for elaborate mathematical equaltions. Just c
Total net income =
$80.29
! I did give full credit to those who used only year 4 numb
Payout Ratio =
56.07%
c. To get to a cash balance of $ 30 million, you would have to issue $ 10.13 million in debt
Total reinvestment
Debt Ratio =
1
$7.60
2
8.36
3
9.196
4
10.1156
28.72%
Problem 5
Expected dividends next year =
Cost of equity =
Growth rate =
Value of Equity =
b. Growth Rate =
Retention Ratio =
Return on equity =
60
8%
4%
1500
4%
40%
10.0%
12%
33.333%
d. When the return on equity is less than the cost of equity. As the payout ratio is increased, the expected growth rate (
! I did give you full credit if you showed the inventory reduction in year 1.
! I was very, very generous on this problem. I did take off 1 point for using non-incremental revenue (operating income)
and 0.5 points for using non-incremental depreciation.
Total
! Divide additional debt by total reinvestment
$35.27
given next year's income, you don't need (1+g), though I did not take off credit for those
recompute the new payout ratio (you cannot keep dividends fixed while raising ROE and holding g constant)
the expected growth rate (which is = (1- payout ratio) ROE) will decrease. If the ROE < COE, the second effect will dominate.
tion in year 1.
Problem 1
a. Unlevered beta prior to restructuring
Levered beta from regression =
Average debt to equity ratio =
Tax rate =
Unlevered beta from regression=
1.2
25%
40%
1.0435
b.
.30 (.80) + .70 (X) = 1.0435
Solving for X,
Unlevered beta of remaining business =
1.147826087
Cash of 30% of firm value is used to retire debt (10%) and buy back stock (20%)
Debt to Equity after =
0.166666667 ! The easiest way to do this is to set up a balance sheet.
D =20 and E =80 before the restructuring; D=10 and E = 60 after
Levered beta after =
1.262608696
Problem 2
As set up by the analyst,
NPV = 1.5 = -10 + Annual Cashflow (PV of annuity, 10 years, 12%)
Solving for the annual cashflow
Annual Cashflow estimated by analys
$2.04
b. Corrections for errors
The cashflows are pre-debt cashflows. The analyst should have used the cost of capital
0.096
Depreciation correction
Depreciation used =
Correct depreciation =
Reduciton in depreciation =
Reduction in tax savings (CF) -
1
0.8
0.2
0.08
Salvage value =
Years 1-10
Year 10
$1.96
3.5
$2.12
b. The other and more complicated solution is to estimate cashflows to equity and discount at the cost
of equity
Investment
Salvage
Debt
After-tax interest expenses
Cashflow to Equity
Net present value at 12% =
0 1-9
-$11.50
$3.45
-$8.05
$2.23
Problem 3
a.
Market value of debt =
10
$471.27
$0.14
$1.82
$300.00
61.10%
14.84500%
4.80%
8.71%
b.
If the value of the firm does not change, the cost of capital after the change should be the same as before.
Cost of capital after =
8.71%
Unlevered Beta =
1.158281117
New Debt ot capital ratio =
0.305514773
New levered beta =
1.464008563
New cost of equity=
11.06%
After-tax Cost of debt after =
3.37%
Pre-tax Cost of debt =
5.61%
Problem 4
NetIncome
CapitalExpenditures
Depreciation
IncreaseinNoncashWorking
DebttoCapitalRatio
Dividends
FCFE
a.
Cashbalanceatbeginning
+ FCFE
Dividends
EndingCashBalance
b.
NetIncome
(CapExDepreciation)(1
ChginWC(1DR)
FCFE
Dividendsthatcouldhavebe
c.Expectednetincomenext
(CapExDeprecn)*(1DR
ChginWC(1DR)
FCFE
Increaseincashbalance=
Amountavailablefordividen
Increaseovercurrentyear
Problem5
a.NetCapEx=
Halifax
$100
$150
$60
$10
0%
$0
$0
$10.00
$0
Donnell
$80
$60
$30
$10
20%
$40
$48
$10.00
$48
Rutland
$50
$30
$15
$5
20%
$30
$34
$10.00
$34
$0
$40
$30
$10
$18
$14
$100
72
8
$20
$20
$100
18
12
$70
20
$50
$20
50
ChangeinWorkingcapital=
TotalReinvestment=
ReinvestmentRate=
Retunoncapital=
Expectedgrowthrate=
10
60
60.00%
10.00%
6.00%
current
EBIT(1t)
Reinvestment
FCFF
$100.00
106
112.36
119.1016
60.00
63.6
67.416
71.46096
$40.00
42.4
44.944
47.64064
$42.40
$44.94
$47.64
b.Retunoncapitalinperpetui
9%
Expectedgrowthinperpetuit
3%
Reinvestmentrateinperpetuit
33.33%
FCFFinyear4=
81.78309867
Terminalvalueatendofyear 1635.661973
c.
Valueofthefirmtoday
FCFF
TerminalValue
PresentValue
Valueofthefirmtoday=
ValueofDebt=
ValueofEquity
Valuepershare
$1,635.66
$38.55
$1,340.38
$400.00
$940.38
$9.40
$37.14
$1,264.69
Problem 1
a.
Business
Unlevered beta Sales
Value/Sales Estimated Value of Business
House Furnishings
1.3
400
1.6
640
Construction Services
0.9
600
0.6
360
Unlevered beta = 1.3(640/1000) + 0.9 (360/1000) =
1.156
Debt/ Equity ratio =
0.666666667
Levered Beta =
1.6184
b.
Cost of equity =
11.473600%
Cost of capital = 11.4736 (.6) + 6.8 (1-.4) (.4) =
c. After expansion plan
New value of construction business =
Value of house furnishings =
Unlevered beta =
Debt to Equity ratio =
New levered beta =
8.52%
560
640
1.11333333
1
1.7813
Problem 2
Revenues
- Printing & production
- Payroll costs
- Depreciation
EBIT
- Taxes
EBIT (1-t)
+ Depreciation
CF to firm
Yrs 1-10
$8,400,000
$2,400,000
$2,000,000
$1,500,000
$2,500,000
$1,000,000
$1,500,000
$1,500,000
$3,000,000
Check
7903703.15
2258200.9
2000000
1500000
2145502.25
858200.899
1287301.35
1500000
2787301.35
NPV = -20,000,000+ 3,000,000 (Pv of annuity for 10 years at 9%) + PV of 5,000,000 at end fo year 10 =
$1,365,027.14
! Forget salvage value: To get a NPV of zero,
Annual cash flow has to be =
Difference in after-tax cash flow =
Difference in pre-tax cashflow =
Difference in number of papers/year =
Difference in number of papers/month =
Breakeven number of papers =
Problem 3
Market value of debt =
PV of Operating leases =
Total Debt=
$22.30
$19.45
$41.75
$20.00
0.162
8.90%
Base
500
150
10
140
42
98
40
50
1
550
165
10
155
62
93
44
50
10
50
27
Cash Balance
80
107
Target cash balance
Cash that can be paid out over next 3 years =
Total net income over next 3 years =
Maximum dividend payout ratio over next 3 years=
Problem 5
Return on capital for the firm =
Reinvestment rate for first 3 years =
1
EBIT (1-t)
$66.00
- Reinvestment
$44.00
FCFF
$22.00
Terminal value
PV of cashflows
$19.64
Reinvestment rate in stable growth =
Terminal value =
Value of firm today =
+ Cash
- Debt
Value of Equity =
Value per share =
2
$72.60
$48.40
$24.20
$19.29
2
605
181.5
10
171.5
68.6
102.9
48.4
50
11
100
-9.7
97.3
3
665.5
199.65
0 ! Did you
199.65
79.86 ! Did you
119.79
53.24
50
12.1 ! Did you
! Did you
remember to t
switch to a 40
compute the c
show repayme
110.93
208.23
50
158.23 ! Did you consider the st
315.69
50.12% ! I did give you full cred
ue of Business
If you use revenue weights: -1
00 at end fo year 10 =
Forget salvage value: -1
,000/1.09^10 + X(PVA,
688.068204
Problem 1
a. Unlevered beta for the firm =0.9 (.6) + 1.4 (.4) =
Debt to equity ratio =
Levered beta = 1.1 (1 + (1-0) (9)) =
1.1
900.00%
11
49.00%
20.20%
1.025
7
8.2
Problem 2
The maximum amount of initial investment will be the amount that makes the net present value zero.
First compute the PV of the cashflows ignoring depreciation
EBIT on Dried Flowers =
$2.00
EBIT on Traditional offerings =
$1.80
! I was gentle here and allowed for multipl
- Over time Salary
$1.00
in overtime is already considered in the op
EBIT w/o depreciation
$2.80
still got full credit.
Taxes
$1.12
$1.68
Incremental EBIT =
$10.32 ! If there was no depreciation, this would be your breakeven in
PV of EBIT for 10 years =
A second best solution for those who abhor algebra
Assume you invest $10.32 million and compute depreciation on that basis
Depreciation tax benefit each year =
PV of depreciation tax benefits for 10 year
Initial investment with depreciation tax ben
Problem 3
a. Current cost of equity =
0.086
Current cost of capital =
7.72%
b. Unlevered beta =
0.782608696
New levered beta =
1.486956522
New cost of equity =
0.109478261
New cost of capital =
7.26%
c. Increase in firm value =
75
Annual Savings =
2.880434783
Annual savings/ (WACC - g) = 2.88/(.0726 -g) = 75
Solve for g,
Expected growth rate=
3.42%
! If you set the problem up right but got the wrong answer, yo
Problem 4
Earnings
Dividends
Cash Balance
22
44
66
44
1
$121.00
$52.80
$68.20
$0.00
$168.20
2
$133.10
$63.36
$69.74
$0.00
$237.94
3
$146.41
$76.03
$70.38
$0.00
$308.32
Problem 5
Reinvestment last year =
50
EBIT (1-t) last year =
60
Reinvestment rate =
83.33%
Return on capital =
12.00%
Expected growth for next 3 years =
b. Terminal value calculation
Stable period reinvestment rate =
Expected EBIT (1-t) in 4 years =
Terminal value =
10.00%
0.333333333
83.0544
1107.392
c. Value today
EBIT (1-t)
Reinvestment
FCFF
Terminal value
Present value
Value of firm
1
$66.00
$55.00
$11.00
2
$72.60
$60.50
$12.10
$10.00
$862.00
$10.00
3
$79.86
$66.55
$13.31
$1,107.39
$842.00
n part a and b, the key question was whether to consider the marginal tax rate. If the problem had asked for
levered beta and a cost of capital without specifying a time period, a reasonable case can be made that the eventual beta
ould be determined by the marginal tax rate of 40% (giving you a beta of 7.04) and the cost of debt would be 10.2%. However
e problem asked for next year's beta and cost of capital. Next year, there is no way the firm will be getting any tax benefits of
ebt. Thus, harsh though it might seem, you lost a point on each if you did consider taxes.
gave full credit even if you did consider a tax rate. I felt you had borne enough punishment
you did not recompute the unlevered beta or used the wrong one, you did lose a point.
here and allowed for multiple interpretations. For instance, if you assume that the $ 1 million
already considered in the operating margin, your incremental EBIT would be $2.28 million. You
this would be your breakeven initial investment. If you go to this point, you got 4 points
ave to multiply by the total number of shares outstanding. If you used remaining shares, you lost a point
use market value of equity alone which is 500
ht but got the wrong answer, you lost only 1/2 point.
on, if you inserted a dollar dividend or put the wrong sign on price change, you would have lost a point
age return on capital, you would have got a lower return on capital but still should have got full credit.
s pulling this out an extra year. It would have cost you 1/2 point
credit if you took your FCFF and terminal value and discounted back at 10%. However, you would have lost credit if you
BIT (1-t) instead of FCFF
e terminal value back at 10% instead of 9%
e terminal value back 4 years instead of 3 years
Problem 1
Market value of equity =
Market value of debt =
Debt/Equity ratio
2000
2000 ! Value of firm (4000) - Value of equity
1
0.9625
1.54
12.1600%
9.08% ! Debt to capital ratio = 50%; Cost of debt = 10%
1.08
0.5 ! Debt drops to $ 1 billion
1.41
11.63%
9.26%
Problem 2
Stated NPV =
100 !
- 700 + CF (PVA, 10 years, 10%) = 100
! The analyst expensed the entire investment in computing NPV
Solve for the CF,
Annual operating cashflow (prior to depreciation)
$130.20
Correct initial investment =
1000
Correct after-tax annual cashflow =
$160.20 ! Add the tax benefit from depreciation to each year's
Correct NPV = -1000 + 160.20 (PVA, 10 years, 12%) =
-$94.86
Problem 3
Cost of equity before =
9.600%
Cost of capital before =
9.0600%
Increase in firm value = (Cost of capital before - Cost of capital after) * Firm value/ (Cost of capital after - Expected grow
150 = (.0906 - X) (1000)/(X - .05)
Solving for X,
Cost of capital after =
8.53%
Unlevered beta =
0.84375
New levered beta =
1.0607142857
New cost of equity =
10.24%
Cost of capital = 8.55% = 10.24%(.7) + After-tax cost of debt (.3)
After-tax cost of debt =
4.61%
Pre-tax cost of debt =
7.68%
Problem 4
Current year
Net Income
- Reinvestment
+ Net debt issued
FCFE
Payout ratio
Next year
100
70
0
30
30.00%
b.
Dividends paid
Stock buyback
Cash returned to stockholders
Effect on cash balance = FCFE - Cash returned =
Cash balance at end of year =
Problem 5
Firm value =
1500
110
77
15.4
48.4
44.00%
44
50
94
-45.6
54.4 ! 100 - 45.6
0.5
1000
700
Spring 2000
Problem 1
Unlevered beta for AT&T =
Unlevered beta for Media One =
Unlevered beta for combined firm =
0.86
1.22
0.95
1.21
Problem 2
Net present value estimated by analyst
- PV of Working capital investments =
($750.00)
$264.99 ! I also gave you full credit if you counted only the se
(I counted 200 right away and 100 in five years)
$844.82
$1,631.56 Comment: You were incredibly creative in trying to co
each year for the 10 years. Given the information in t
$513.41
$800.00 ! It is only the difference in tax benefits that matters.
- PV of Salvage =
+ PV of Terminal Value =
- PV of depreciation tax benefits
+ PV of expensing tax benefit
Corrected net present value
$58.33
Problem 3
Current Cost of Equity =
Current after-tax cost of debt =
Current Cost of Capital =
9.96%
3.72%
9.07% ! Current cost of capital'
Unlevered Beta =
New Levered beta =
New Cost of Equity =
New After-tax cost of debt =
Cost of Capital =
0.9
1.26
11.04%
0.045
8.42% ! New cost of capital
$21.62 ! In billions
$5.40
b.
Current interest expense on debt =
Book Value of Debt outstanding =
Market value of debt at 7.5% =
Drop in value of debt =
Total Change in firm value =
Change per share =
2.48
40
$36.43
$3.57
$25.19
$6.30
!
!
!
!
1000
2500 +.2 X
Check
1500
950
1000
3450
4750
1500
.2 X
+
+
+
+
=
Depreciation
Capital Expenditures
Change in non-cash working capital
Net Debt Issued
FCFE
Solve for X
Net Income in 1998 =
2000
-3000
500
-800
2500 +.2X
2000
-3000
500
-800
3450
4750
Problem 5
Exp. Growth
EBIT (1-t)
ROC
Cost of Capital
Reinvestment Rate
EBIT(1-t)
- Reinvestment
FCFF
Terminal Value
Cumulated Cost of Capital
Present Value
Value of Firm =
- Value of Debt outstanding =
Value of Equity =
Value per share =
1
15%
115
20%
12%
2
15%
132.25
20%
11%
75.00%
75.00%
$115.00
$86.25
$28.75
1.12
$25.67
$2,026.29
800
$1,226.29
$12.26
$132.25
$99.19
$33.06
1.2432
$26.59
1974.025974
33.33%
$159.69
$53.23
$106.46
he problem by reestimatin
You then used the lower cost
increase in the stock price
rack, doing this will lock i
this benefit for only 10 ye
Spring 1999
Problem 1
Unlevered Beta for Pepsi = 1.2 / (1 + 0.6*(0.1)) =
Current Levered Beta = 1.13 (1 + 0.6*(10/40)) =
1.13
1.30
1.0750
Problem 2
Cost of Equity = 5% + 1.25 (6.3%) =
12.875%
PV of Cash Flows = 15/.12875 =
$
116.50 ! Net cap ex and working capital are both zero
Equity Invested in Project = 0.6*150 =
90 ! Only equity investment considered
NPV of Project = 116.5 - 90 = $ 26.5 million
If you want to do this analysis on a firm basis, you have to compute the EBIT (1-t)
EbIT (1-t) = FCFF = 15 + 60*.08*(1-..4) =
17.88
Cost of Capital = 12.875% (0.6) + 4.8% (.4) =
0.09645
NPV = 17.88/.09645 - 150 =
$
35.38
Problem 3
Current Cost of Equity = 5% + 0.9 (6.3%) =
Current Cost of Capital = 10.67% (.9) + 6% (1-.4) (.1)=
10.67%
9.963%
0.84375
1.18125
12.43%
9.138%
1,994
100 ! New Debt taken = Debt at optimal - Current debt = 4000 - 1000 = 3000
200
$
9.97
1996
$150
1997
$225
1998
$315
1999
$394
2000
$492
Capital Expenditures
Depreciation
$200
$125
$250
$190
$300
$250
$375
$313
$469
$391
$300
$330
$375
$469
$586
Net Income
- Net Cap Ex (1- Debt ratio)
- Chg in WC (1-DR)
FCFE
Dividends
Cash Balance
Non-cash WC
$150
67.5
22.5
$60
$30
$130
$225
54
27
$144
$45
$229
$315
45
40.5
$230
$63
$396
$375
$393.75
$56.25
$84.38
$253
$79
468.75
$174
$492.19
$70.31
$105.47 ! Change in 1999 computed from total WC
$316 below
$98
Total
585.9375
$218
$392
Problem 5
Return on Capital in 1998 =
600 (1-.4)/2000 =
18.00%
Reinvestment Rate in 1998 = (360-300+50)/360 =
0.305555556
Expected Growth Rate = 18% (.3056) =
5.50%
Cost of Equity = 5% + 1.1 (6.3%) =
0.1193
Cost of Capital = 11.93% (.7) + 7.5% (1-.4) (.3) =
9.70%
FCFF = EBIT (1-t) - (Cap Ex - Depreciation) - Chg in WC = 360 - (360-300) - 50 = 250
Firm Value = 250*1.055/(.097-.055) =
$
6,280 ! Getting the right answer is not enough. You have to justify the growth rate.
- 1000 = 3000
ptimal value
Spring 1998
Problem 1
a. Cost of Equity = 6% + 0.67 (5.5%) =
9.69%
b. Bottom-up Beta
Pharmaceutical Business = 1.15/(1+0.6*0.1) =
1.08
Specialty Chemical Business = 0.70/(1+0.6*0.35) =
0.58
Unlevered Beta for Mallinckrodt = 1.08 (255.4/306.9)+ 0.58 (51.5/306.9) =
c.
Current Debt/Equity Ratio = 556.9/(32*73) =
23.84%
Levered Beta for Mallinckrodt = 1.00 (1 + 0.6*(.2384)) =
1.00
1.14
Problem 2
a. Return on Equity = $ 190.10/1231.20 =
15.44% ! I used the beginning of the year book value of
b. Equity EVA = (.1544 - .0969) (1231.20) =
$
70.80
c. Divisional EVAs
Division
EBIT
Capital Inves ROC
Levered Beta Cost of Equity Cost of Capita
Pharma
$
255.40 $ 1,298.00
11.81%
1.24 $
0.1282
11.14%
Spec Chem
$
51.10 $
601.00 $
0.05
0.66
9.64%
8.57%
Problem 3
Pre-tax Cost of Debt for Mallinckrodt = 6.80% (Based upon interest coverage ratio and rating of A+)
Cost of Capital = 9.69% (32*73/(32*73+556.9)) + 6.80% (1-.4) (556.9/(556.9/(32*73+556.9)) =
b. Optimal Cost of Capital
Pre-tax Cost of Debt at Optimal =
7.25% (Based on interest coverage ratio at optimal)
Unlevered Beta = 0.67/(1+0.6*0.2384) =
0.586156215
New Beta = 0.60 (1+0.6*(40/60)) =
0.820618701
New Cost of Equity = 6% +0.84*5.5% =
10.51%
New Cost of Capital = 10.62% (.6) + .0725*.6*.4 =
8.05%
c. Value of Firm = 32*73+556.9 =
2892.9
New Dollar Debt at 40% Debt Ratio = 0.4*2892.9 =
1157.16
Additional Debt to be taken = 1157 - 556.9 =
600.26
Weighted Duration of Debt = (12/1157)(0.5) + (545/1157)(3)+(600/1157)X = 6.5
Solve for X,
X=
9.80
Problem 4
Net Income
+ Depreciatio
+ Cex
+ Chg in WC
+ Net Debt i
FCFE
1996
212
149
-169
-152
608
648
Dividends
$
+ Buybacks $
Cash Returned $
45.70
131.00
176.70
Cash Returned
27.27%
1997
190
128
-170
34
-113
69
$
$
$
48.20
150.00 ! I did not net out stock issues. If you did, specify that you did so
198.20
287.25%
c.
Return on Capital = 307(0.6)/(109+558+1232) =
Net Cap Ex/Revenues = (170-128)/1861 =
Predicted Dividend Yield = 0.03 - 0.053(.097) - 0.15(.0226) =
Predicted Dividend = 0.0215 * $ 32 =
$
0.69
Problem 5
9.70%
2.26%
2.15%
EBIT (1-t)
+ Deprecn
- Cap Ex
- Chg in WC
FCFF
Base
$
184.20
$
128.00
$
170.00
$
$
$
$
$
1
202.62
140.80
187.00
50.30
106.12
$
$
$
$
$
2
222.88
154.88
205.70
55.33
116.73
$
$
$
$
$
3
245.17
170.37
226.27
60.86
128.41
Terminal Year
$
252.53
$
175.48
$
193.03 ! Used industry average cap ex/d
$
20.08
$
214.89
Revenues
$ 1,861.00 $ 2,047.10 $ 2,251.81 $ 2,476.99 $ 2,551.30
WC
$
503.00 $
553.30 $
608.63 $
669.49 $
689.58
% of Revenue
27.03%
27.03%
27.03%
27.03%
27.03%
b. Terminal Value Calculation
Cost of Equity in stable growth = 6% + 1(5.5%) =
Cost of Capital in Stable growth = 0.115(.6)+.07*.6*.4 =
Terminal Value = 215/(.0858-.03) =
$
0.115
8.58%
3,851
EVA
$
8.67
$
(20.83)
0.80749421
8.61%
tio at optimal)
8.61%
Spring 1997
Problem 1
Cost of Equity for the project = 7% + 1.5 (5.5%) =
Cost of Capital = 15.25% (.6) + 10% (1-.4) (.4) =
NPVof project = -40 + 10 (1-.4)/.1155 =
Problem 2
Business
Unlevered Bet Weight
Beta *Weight
Tech
1.51
33.33% 0.503144654
Auto Parts
1.02
26.67% 0.271186441
Financial Services
0.72
40.00%
0.2875
1.06
Levered Beta = 1.06 (1+ (1-.4) (40/60)) =
1.49 ! Use debt to equity, not debt to capital
Problem 3
Firm Value before change =
Firm Value after change =
2000
2200 ! I have assumed investors are rational and that they sold their stock ba
If you assume that the stock buyback was at $ 40, you will get a smaller
200
11.40%
0.96
$
$
750
1.80
2.40 ! Change in stock price = Dividends (1- ord tax rate)/ (1- capital gains ra
208.33 ! Divide total dividends paid by dividends per share
Problem 5
a. Expected growth rate in perpetuity = ROE * Retention Ratio = .15 * .4 =
6.00% ! Cannot just assume a grow
Value per share = EPS (Payout ratio) (1+g)/(r-g) =
$
19.57 ! Used 5.5% risk premium and beta of 1
b. New growth rate with higher retention ratio = 14% *.5 =
Value per share = EPS (Payout ratio) (1+g)/(r-g) =
7%
$
19.45
Problem 6
a. False
b. False. Firms may pay out more in dividends than they have available in FCFE.
c. True
d. True. It may be the same for an unlevered firm, but it cannot be lower.
Spring 1996
Problem 1
a. Unlevered Beta for Samson = 0.90/(1+(1-0.4)(.05)) =
0.873786408 ! Used the average debt/equity r
New Levered Beta = 0.87(1+(1-.4)(.25)) =
1.0005
New Cost of Equity = 8% + 1(5.5%) =
13.50%
b. Cost of Capital = 13.50%(.8) + 10%(1-.4)(.2) =
12.00%
c. The debt ratio currently is 20%. Doubling the debt ratio will increase it to 40%.
New Levered Beta = 0.87(1+(1-.4)(.40/60)) =
1.218
New Cost of Equity = 8% + 1.22(5.5%) =
14.71%
New Cost of Capital = 14.71%(0.6)+11.5%(1-.4)(0.4) =
11.59%
d. Value of Firm today = 240+60 =
300
Dollar Debt at 40% debt ratio = 0.4*300 =
120
Additional Debt needed = 120 - 60 =
60
e. Value of Equity in 3 years = 240(1.135)^3 =
$
351 ! This is probably understated. The beta will rise
Dollar Debt in 3 years = (0.4/0.6) ($ 351) =
$
234.00
f. Return on Capital in most recent year = 40(1-.4)/100 =
24.00% ! I used the book value at the beg
The firm is making a return on capital that is higher than the cost of capital. If it can continue to do so, I would suggest
Problem 2
a. FCFE in 1995 = Net Income + Deprecn - Cap Ex - Chg in Non-cash WC -(Principal Repaid + new Debt issued)
=150+20-70-10+15 =
105
Cash Balance increased by $ 50 million
Dividends paid must have been $ 55 million
b. Capital Expenditures = Change in Fixed Assets + depreciation = 50 + 20 = 70
Cash Balance increased by $ 50 million
c.
Net Income
165
- Net Cap (1-DR)
21 ! See below for calculation of net cap ex.
- Chg in WC (1-DR)
4.5
FCFE
$
139.50
Project
ROC
Beta
Cost of Equity Cost
A
13.34%
1.2
13.60%
B
9.99%
1
12.50%
C
12.51%
1.1
13.05%
D
14.28%
2
18.00%
Accept projects A and C; total cap ex = $ 50 million
Depreciation next year = 20*1.1 = 22
Net Cap Ex = 50-22 =
28
of Capital
11.40% ! Use firm's debt ratio of 25% and firm's after ta
10.58%
10.99%
14.70%
Problem 3
a. Return on Capital =
25%
Debt/Equity Ratio =
25%
Interest rate on debt =
8%
Expected Growth = .67(25% + .25(25%-8% (1-.4))) =
20.13%
b.
Current
1
2
3 Term. Year
EPS
$
3.00 $
3.60 $
4.33 $
5.20 $
5.51 ! Use a stable growth rate; I used
DPS
$
1.00 $
1.20 $
1.44 $
1.73 $
3.63
Payout Ratio
33.33%
33.33%
33.33%
33.33%
65.81% ! Payout Ratio in stable growth=1
c. Terminal Value per share = 3.63/(.125-.06) =
$
55.85
d. Value per share today = 1.20/1.1415 + 1.44/1.1415^2+(1.73+55.85)/1.1415^3 =
Cost of Equity today = 7% + 1.3 (5.5%) =
0.1415
e. If there is no net cap ex or working capital investment, the expected growth after year 3 has to be zero
EPS
$
3.00 $
3.60 $
4.33 $
5.20 $
5.20
- Net Cap Ex(
1.2 $
1.44 $
1.73 $
2.08
0
- Chg in WC (
0
0
0
0
0
FCFE
$
2.16 $
2.60 $
3.12 $
5.20
Current debt ratio = 20% (D/E ratio of 25% translates into debt ratio of 20%)
Terminal Value per share = 5.20/.125 =
$
41.61
Value per share today = 2.16/1.1415+2.60/1.1415^2+(3.12+41.61)/1.1415^3 =
$
33.96
(If you had used a 6% growth rate forever in this case as well, the assumptions would have been inconsistent.)
6
Used the average debt/equity ratio over period)
used the book value at the beginning. If you decide to use averages, specify it here
ntinue to do so, I would suggest it take projects
r 3 has to be zero
40.87
Fall 1995
Problem 1
a. To estimate market interest rate,
Yield to maturity on the debt =
9.31% ! If you are short of time, you can use the short cut = Inte
Estimated market value of bank debt =
$
39.52 ! Assumed that it was balloon payment debt.
Total Market Value = 42.5+39.5 =
82
After-tax Cost of Debt = 9.31%(1-.4) =
5.59%
b. Average Beta for comparable firms =
1.04
Average D/E Ratio for comparable firms =
22%
Unlevered Beta for comparable firms =
0.918727915
Levered Beta for SDL = 0.92 (1+0.6*(82/400)) =
1.03
(See below for calculation of debt)
Cost of Equity = 6% + 1.03 (5.5%) =
11.68%
c. Cost of Capital = 11.68% (400/482) + 5.59% (82/482) =
10.76%
d. SDL's debt seems much too long term for its needs. (The debt duration is only 1.5 years)
I would convert the debt into shorter term debt. I would keep it dollar debt since it does not seem to be affected by the
e. Unlevered beta after acquisition = 0.92(482/632)+1.25(150/632) =
0.998322785
New Dollar Debt = 82 + 150 =
232
New Debt/Equity ratio = 232/400 =
0.58
New Levered Beta = 1.00 (1+0.6*0.58) =
1.348
New Cost of Equity = 6% + 1.348(5.5%) =
13.41%
New Cost of Capital = 13.41% (400/632) + 9.5%(1-.4) (232/632) =
10.58%
Problem 2
a.
Net Income
- Net Cap Ex
- Chg in WC
FCFE
150
75 ! No debt
20
55
If cash balance increased by $ 25 million, the dividend must have been $ 30 million.
b.
Project
ROE
A
B
C
D
Take projects A, C and D
COE
13%
16%
12%
15%
Net Income
165
- Net Cap Ex (1-.2)
72
- Chg in WC (1-.2)
8 ! Working capital will increase by 10%, if revenues increase 10%
FCFE
85
The firm can afford to return $ 85 million to its equity investors
Problem 3
a. Expected growth during high growth period = 0.8 (20%) =
16% ! ROE = EPS/BV ofEquity = 2
b.
1
2
3 Terminal year
EPS
$
2.32 $
2.69 $
3.12 $
3.31
DPS
$
0.46 $
0.54 $
0.62 $
2.10
Payout ratio
20%
20%
20%
63.53% ! Payout ratio in stable phase=.06/(.14+.25
Cost of Equity
14.25%
14.25%
14.25%
11.06% ! Levered Stable beta = 0.8(1+0.6*.25) ); T
(I used a cost of debt of 7% after year 3. It has to be greater than 6%, which is the T.Bond rate)
Terminal Value = 2.10/(.1106-.06) =
$
41.50
29.06
stable phase=.06/(.14+.25(.14-.07*.6))
beta = 0.8(1+0.6*.25) ); Tax rate used =40%]
8.24%
Fall 1994
Problem 1
a. Market Value of debt = 5 (PVA,10%,10) + 60/1.1^10 =
b.
Business
Beta
D/E
Unlev Beta
Record/CD
1.15
50%
0.88
Concert
1.2
10%
1.13
Unlevered Beta for JP = 0.88 (.75) + 1.13 (0.25) =
0.9425
Levered Beta for JP = 0.9425 (1+(1-.4)(53.86/240)) =
1.07
Cost of Equity = 8% + 1.07 (5.5%) =
13.89%
c. Cost of Capital = 13.89% (240/293.86) + 10%(1-.4)(53.86/293.86) =
d. If the treasury bond rate rises to 9%,
New Market Value of Debt = 5 (PVA,11%,10) + 60/1.11^10 =
Cost of Equity = 9% + 1.07 (5.5%) =
14.89%
Cost of Debt =
11%
Cost of Capital = 14.89% (240/290.58) + 11% (1-.4) (50.58/290.58) =
53.86
12.44%
$
50.58
13.45%
Problem 2
Project
IRR to Equity Cost of Equity
A
16.00%
16.80%
B
15.00%
14.88%
C
12.50%
13.50%
D
11.50%
10.75%
Accept projects B and D
a.
Net Income
$
57.60
- (Cap Ex - Depr) (1-DR) $
28.10 ! (50 - 13(1.2))(1-(53.86/293.86))
! I would also have given you credit
- Chg in WC (1-DR)
$
4.90 ! Working capital is 20% of revenues
FCFE
$
24.60
b. Dividends next year = 0.25*(57.60) =
$
14.40
Expected increase in cash balance = (24.60-14.4) =
$
10.20
Problem 3
a. Expected growth rate = .75(.48) =
36%
! If you use current ROE = 48/100 = 48%
The expected growth rate will be slightly lower if the market value debt to equity ratio and interest rate is used to get t
Expected growth = .75 (.3188+ 53.86/240 (.3188-.06)) =
28.26%
If book value debt/equity ratio and book interest rate is used, the answer will be 35.55%
I am going to use the 27.46% growth rate because I think it is more sustainable.
b. Expected Dividends
Current
1
2
3
4
EPS
$
4.00 $
5.13 $
6.58 $
8.44 $
10.83
DPS
$
1.00 $
1.28 $
1.65 $
2.11 $
2.71
Payout Ratio
25.00%
25.00%
25.00%
25.00%
25.00%
c. Stable Payout Ratio = 1 - [.06/(.15+(53.86/240)(.15 - .06)] =
64.75%
d. Terminal Value
Cost of Equity in stable growth =
13.50%
Terminal Value = $ 9.53/(.135-.06) =
$
127.06
e. Value today (discounting at current cost of equity of 13.89%)
Cost of Equity during high growth =
13.89% ! See problem 1
DPS + Term Price
$
1.28 $
1.65 $
2.11 $
2.71
PV
$
1.13 $
1.27 $
1.43 $
1.61
Value per share =
$
73.55
Problem 4
a. New Fundamentals:
Return on Capital = (85-5)*(1-.4)/(160-50) =
0.955
1.12
1994
! I estimated the market value of the debt
given the current market interest rate of 10%
! You can even re-estimate the levered beta with this new debt
but it won't change by much.
0.0034
$
$
5
13.88
3.47
25.00%
$
$
130.53
68.12
! I am assuming that there was no cash at the start of the year. If there
had been, I would have netted it out.
Term Year
$
14.72
$
9.53
64.75%
Book Value of capital drops $ 50 mil after buyback: I am adjusting the beginning of the year book capital by this.
Fall 1993
Problem 1
KentuckyFriedChicken
Hardee's
Popeye'sFriedChicken
RoyRogers
UnleveredBeta=
1.05
1.2
0.9
1.35
1.125
0.9183673
0.2
50%
10%
70%
0.375
1a.Firstcalculatethebetabaseduponcomparablefirms:
AverageBeta=
1.125
AverageD/ERatio=
0.375
Unleveredbeta=
0.91836735
BetaforBostonTurkey= 1.2627551
Usethisbetatocalculatethecostofequity
CostofEquity=6.25%+1.26*5.5%=
13.18%
(Alternativelythelongbondratecouldhavebeenusedastheriskfreerate,witha5.5%premium)
1b.AftertaxCostofDebt:
Firstcomputetheinterestcoverageratio=EBIT/InterestExpense=
ThisyieldsabondratingofA,andapretaxrateof7.50%=6.25%+1.25%
Aftertaxcostofdebt=7.5%(10.4)=
4.50%
1c.MarketValueofEquity=20*100000=
$2,000,000
MarketValueofDebt=1.25*1000000=
$1,250,000
1c.CostofCapital=13.18%(2/3.25)+4.5%(1.25/3.25)=
1d.NewDebtEquityratioafterrepurchase=
Newbetaafterrepurchase=
Newcostofequity=6.25%+1.56*5.5%=
9.84%
1.1666666667
1.5612244898
14.83%
1e.Newaftertaxcostofdebt=7.75%(10.4)=
4.65%
Newcostofcapital=14.83%(1.5/3.25)+4.65%(1.75/3.25)=
9.35%
ChangeinFirmValue= 3,250,000(.0984.0935)/.0935=
$171,419
Changeinstockpricepershare=
$1.71 !Dividebythetotalnumb
2a.Firstdecidewhichprojectsyouwillaccept
Project
ROE
CostofEquity
A
12.50%
11.75% Accept
B
14.00%
14.50% Reject
C
16.00%
16.15% Reject
D
24.00%
17.25% Accept
Nextcalculateworkingcapitalas%ofRevenues
WorkingCapital=CurrentAssetsCurrentLiabilitie
WorkingCapitalas%ofRevenues=50%
IncomeStatementNextyear
Revenues
Expenses
Depreciation
=EBIT
InterestExp
=TaxableInc.
Tax
=NetIncome
(CapExDeprec)(1)
WC(1)
=FCFE
$500,000
1100000
440000
100000
560000
100000
460000
184000
276000
30000 (150000100000)(10.4)
30000 (50%ofincreaseinrevenues($100000))*(10.4)
216000
2b.CashBalancenextyear=CurrentBalance+FCFEDividends=150000+216000100000=266000
2c.Ordinarytaxrate=40%
CapitalGainstaxrate=28%
(PricebeforePriceafter)/Dividend=(10.4)/(10.28)=0.833
Changeinprice=$0.833
3a.RetentionRatio=1(1/2.4)=
58.333%
ROC=(EBIT(1t))/(BVofDebt+BVofEquity)=
12.00% ! You can estimate ROE directly by dividing
Debt/EquityRatio=1.25/2=
0.625 !Ifyoudecidetousebookvaluedebttoequityratio,speci
Interestrate=Marketinterestrateondebt=
7.50%
ExpectedGrowthRate=0.5833(0.12+0.625(0.120.045)=
9.73%
3b.Terminalprice=Priceattheendofyear3
CostofEquity=6.25%+1(5.5%)=
PayoutRatioattheendofyear3=1(0.06/(0.12+0.625(0.120.045)))=
Terminalprice=($2.40*1.0973^3*1.06*0.6404)/(0.11750.06)=
3c.
Year
11.75%
0.64044944
$37.44
DPS
1 $1.10
!Growingat9.73%estimatedabove
2 $1.20
3 $1.32
$37.44
CurrentCostofEquity(baseduponcurrentbeta)=
13.18% !Seeproblem1forcalculation
PresentValueofDividendsandTerminalPrice=
$28.65
Dividebythetotalnumberofsharesoutstanding.
00000=266000
e ROE directly by dividing net income by book equity, but your answer will be different.
debttoequityratio,specifyithere
forcalculation
Fall 1992
1a. Current Cost of Equity = 8% + 1.15 (5.5%) =
14.33%
Current after-tax Cost of Debt = 10% (1- 0.4) =
6.00%
Current Weighted Average Cost of Capital = 14.33% (0.8) + 6.00% (0.2) =
1b. New Debt Ratio = (200+200)/1000 =
40.00%
Unlevered Beta = 1.15/(1+0.6*.25) =
1.00
New levered beta = 1.00 (1+0.6*0.67) =
1.40
New Cost of Equity = 8%+1.40 (5.5%) =
15.70%
New Cost of Capital = 15.70% (0.6) + 6.60% (0.4) =
12.06%
1c. Change in Firm Value = 1000 (.1266-.1206)/.1206 =
$
49.75 millions
Increase in Stock Price = $49.75 million/ 40 million =
$
1.24
1d. Debt next year = $ 200 + $150 = $350 million
Expected Price Appreciation in Equity = Expected Return - Dividend Yield = 14.33%-10% = 4.33%
Expected Value of Equity = 800 (1.0433) =
$
834.64
Expected Debt/Equity Ratio at end of next year = $350/$835 =
41.92%
2a.
Net Income
+ Deprec'n
- Cap. Ex.
- Chg. WC
= FCFE
Dividends
(Assuming that net capital
Cash Balance
1
2
3
$
110.00 $
121.00 $
133.10
$
54.00 $
58.32 $
62.99
$
60.00 $
60.00 $
60.00
$
10.00 $
10.00 $
10.00
$
94.00 $
109.32 $
126.09
$
66.00 $
72.60 $
79.86
investment and working capital is financed with equity)
$50.00
$78.00
$114.72
$160.95
$
$
$
$
100.00
50.00
60.00
10.00
2.39
Problem 3
4
1
2
3
3.31
EPS
$
2.40 $
2.78 $
3.12 $
61.54% ! Payout ratio = 1 - g/ROE, where RO
Payout Ratio
0.00%
25.65%
36.17%
2.03
DPS
$
$
0.71 $
1.13 $
Beta
1.4
1.25
1.1
1
Cost of Equity
0.142
0.13375
0.1255
0.12
Note: The alternative to estimating a levered beta in year 4 is to assume a beta of 1.
Terminal Price = $2.03/(.12 - .06) =
33.90
24.59
12.66%
%-10% = 4.33%
Payout ratio = 1 - g/ROE, where ROE = ROC + D/E (ROC - I (1-tax rate))