Problem 1

Price/BV for AlumCare = 4

P/BV ratio for HealthSoft = 2
If AlumCare's Price is thrice that of HealthSoft,
Let MV of Equity for AlumCare = $ 100.00
Then MV of Equity for HealthSoft = $ 33.33
BV of Equity for AlumCare = $ 25.00
BV of Equity for HealthSoft = $ 16.67
P/BV of Equity after merger = (100+33.33)/(25+16.67) =

Problem 2
Expected Growth = Net Margin * Sales/BV of Equity * Retention Ratio
.06 = Net Margin * 3* .40
Net Margin = 0.05
Price/Sales Ratio = .05 * (1.06)* .6/(.12 - .06) = 0.53

Problem 3
Unlevered Beta (using last 5 years) = 0.9/(1+(1-.4)(.2)) =
Unlevered Beta of Non-cash assets = 0.80/(1-.15) =

Levered Beta for Non-cash assets = 0.94 (1+0.6(.5)) =

Cost of Equity for Non-cash Assets = 6% + 1.22(5.5%) =
Cost of Capital for Non-cash Assets = 12.71%(.667)+.07*.6*(.333)=

Estimated FCFF next year from non-cash assets = (450-50)(1-.4)(1.05)-90 =

Estimated Value of Non-cash Assets = 162/(.0988-.05) =
Cash Balance
Estimated Value of the Firm =
- Value of Debt Outstanding =
Value of Equity
3.20

0.80
0.94

1.222
12.71%
9.88%

$ 162
$ 3,320
500
$ 3,820
800
$ 3,020
Problem 1
After-tax Operating Margin = 0.18
WACC = 13.55% (.6) + 6% (.4) = 0.11
Value/Sales Ratio = .18 (1.05) / (.1053-.05) = 3.42

Value/Sales Ratio of Generic Brand = 3.42 * 0.5 = 1.71

Value of Brand Name = 342 - 171 = 171 million

Part II
a. True; if firms have different risk levels, they will have different PE/g ratios.
(Some of you also pointed out that the growth periods have to be the same. That is true too.

b. Firm B will have the higher Value/EBITDA multiple.

Everything else about the two firms is identical.

c. Price/BV ratio will drop by more than half.

d. P/BV = 2.5
Value of Equity will drop by 30% after special dividend.
Value of Book Value will drop by same dollar amount.
Net Effect = (2.5 * .7) / (1 - .75) = 7
Problem 1
Expected PE/g ratio for GenieSoft = 2.75 - 0.50 (2) = 1.75
Expected PE/g ratio for AutoPred = 2.75 - 0.50 (1) = 2.25
Actual PE/g ratio for GenieSoft = 50/40 = 1.25
Actual PE/g ratio for AutoPred = 20/10 = 2.00
Both GenieSoft and AutoPred are undervalued relative to the market.

Problem 2
EBITDA $ 550
Depreciation $ 150
EBIT $ 400
EBIT (1-t) $ 240
Next Year
EBITDA $ 578
EBIT $ 420
EBIT (1-t) $ 252
- Reinvestmen $ 84
FCFF $ 168

Firm Value $ 4,200

Value/FCFF 25.00
Value/EBIT 10.00
Value/EBITDA 7.27

Problem 3
I would use a higher Value/EBITDA multiple because the comparable firms have a lower return on capital.
turn on capital.
Problem 1
Value of Equity in Common Stock = 50 * $ 20 = $ 1,000.00
Value of Equity in Management Options = 10 * $ 15 = $ 150.00
Value of Conversion Option = 140 - 100 = $ 40.00
Value of Equity = $ 1,190.00

Value of Equity = $ 1,190.00

Value of Debt = $ 150.00
Value of Firm = $ 1,340.00
- Value of Cash = $ 250.00
Value of non-cash assets = $ 1,090.00

Problem 2
a. Firms with high risk and/or low quality projects (ROE) will have low PEG ratios
I would therefore Delphi Systems for my undervalued stock. It has a low PEG ratio, low risk and a high ROE
b. Firms with low risk and high quality projects will have high PEG ratios
I would therefore pick Connectix as my overvalued stock, since it has a high PEG ratio, high risk and a low ROE.

Problem 3
a. Value/FCFF = (1+g)/(WACC - g) = 1.05/(.10-.05) = 21 ! Answer is 20 if you look at Value/FCFF1
(If you assume that the multiple is Value/Current FCFF, this will become (1+g)/(WACC - g) which would yield 21.
b. If the ROC is 12.5%, the reinvestment rate = g/ROC = .05/.125 = 0.40
FCFF = EBIT (1-tax rate) ( 1 - Reinvestment Rate) = EBIT (1-.4)(1-.3)
Value /EBIT = 21 (1-.4) (1-.3) = 8.82 ! Answer is 8.40 if you look at Value/EBIT1
 and a high ROE

h risk and a low ROE.

you look at Value/FCFF1

which would yield 21.

f you look at Value/EBIT1

Problem 1
Current PBV = (ROE - g) / (COE - g)
1.5 = (ROE - 5%)/(12%-5%): Solving for ROE = 15.5%
If you add 3% to ROE, ( I also gave full credit if you used 15.5% (1.03))
PBV = (.185-.05)/(.12-.05) = 1.93 1.9286
This assumes that the growth stays the same, but payout ratio goes up
If you had assumed that the payout ratio would remain the same, but growth would change:
Current Payout Ratio = 5/15.5 = 32.26%
New Growth Rate = 0.32 * 18.5% = 5.92%
New PBV = (.185-.0592)/(.12-.0592) = 2.07

Problem 2
Predicted V/S Ratio for Estee Lauder = 0.45 + 8.5 (.16) = 1.81
Predicted V/S Ratio for Generic Company = 0.45 + 8.5 (.05 0.875
Difference in V/S Ratios = 0.935
Value of Estee Lauder Brand Name = 0.935 (500) = $ 467.50

Problem 3
Value of Straight Debt portion of Convertible = 12.5 (PVA, 10%, 10 years $ 173.19
Value of Conversion Option = 275 - 173.2 $ 101.81

Value of the Firm = $ 1,000.00

Value of Straight Debt = $ 273.19
Value of Equity = $ 726.81
Value of Conversion Option = $ 101.81
Value of Warrants = $ 100.00
Value of Equity in Stock $ 525.00
Value per Share = $ 26.25
Problem 1
FCFF on non-cash assets = $ 200 million (1-.4) ( 1 - 4/10) = 72 ! Reinvestment rate = g/ ROC = 4/10
Unlevered Beta for non-cash assets = 1.20/.9 = 1.333333333 ! Reflects the fact that the average fi
Levered Beta for non-cash assets = 1.33 (1 + 0.6(15/85)) = 1.470823529
Cost of Equity for non-cash assets = 6% + 1.47 (5.5%) = 14.09%
Cost of capital for non-cash assets = 14.09% (.85) + 10% (1-.4) (.15) = 12.88%
Value of non-cash assets = 72 (1.04)/(.1288 - .04) = $ 843.24
Value of cash = 250
Value of firm = $ 1,093.24

Problem 2
PE = Payout ratio (1+g)/(r - g)
Payout ratio = PE (r -g)/(1+g)
r = Cost of Equity = 6% + 0.9*5.5% = 10.95%
g = 5%
PE = 10.59
Payout ratio = 10.59(.1095 - .05)/(1.05) = 0.60
g = (1-Payout ratio) (ROE)
.05 = (1 - .6) ROE
ROE = 12.5%

Problem 3
Firm Value = 5000 + 1500 + 1000 = 7500
Firm Value net of cash = 7500 - 1750 = 5750
Taxable Income = 250/(1-.4) = 416.6666667 ! Net income includes interest income
Taxable Income before interest income = 291.6666667
EBIT = 291.67 + 100 + 80 = 471.67
EBITDA 721.67
Non-cash Value/EBITDA = 5750/722 = 7.96 ! If numerator is non-cash, denominator cannot include interest in
Alternatively,
Firm Value = 5000 + 1500 + 1000 = 7500
EBITDA + Interest Income = 846.67
Value/EBITDA = 7500/847 = 8.854781582
einvestment rate = g/ ROC = 4/10
eflects the fact that the average firm has 10% debt

minator cannot include interest income

Problem 1
EBIT at Reliable without auto parts subsidiary = 500 - 200 = 300
EBIT at Chemical products subsidiary = 250
EBIT at Auto Parts Subsidiary = 200

Tax rate = 40%

Reinvestment Rate = (Growth/ROC) = 6%/12% = 50%
Cost of Capital = 10%

Value of Reliable (stand-alone) = 300 (1-.4) (1-.5)(1.06)/(.10-.06) = $ 2,385 ! Alternatively, we could have valued
Value of Chemical subsidiary = 250 (1-.4)(1-.5)(1.06)/(.10-.06) = $ 1,988 the auto parts subsidiary.
Value of Auto Parts subsidiary = 200 (1-.4)(1-.5)(1.06)/(.10-.06) = $ 1,590

Value of Reliable (with subsidiaries) = 2385 + 0.1 (1988) + 0.5 (1590) = $ 3,379
Value per share = $ 33.79

Problem 2
a. will become more sensitive to changes in expected growth rates. (The value of growth is a present value effect)
b. Firm A will have the higher PEG ratio, because it has the lower expected growth rate.
c. Low tax rate, high return on capital, low reinvestment rate: Best possible combination
d. The price to book value ratio will drop. The simplest way to do this is to use the following equation:
PBV = (ROE - growth rate)/(Cost of equity - growth rate)
Inciientally, this is true only if the price to book value ratio is greater than 1, which it is in this case.

e. Enterprise Value = (Market Value of Equity + Market Value of Debt - Cash and Marketable Securities)/(EBIT + DA)
= (150 *10 + 1000-500)/(250+100) = 5.71
 lternatively, we could have valued Reliable on a consolidated basis and subtracted the 50% of
e auto parts subsidiary.

s a present value effect)

e Securities)/(EBIT + DA)
Problem 1
a.
Revenues 1050
EBIT 210
EBIT (1-t) 168
+ Depreciation 105
- Cap Ex 160
- Chg in WC 13 Only the change in working capital matters
FCFF 100
Reinvestment 68 ! I was pretty flexible on how this was computed….
b.
Reinvestment Rate 40.48%
Expected growth rate 5%
Return on Capital = 12.35%
c.
Reinvestment rate 0.5 ! As ROC changes, the reinvestment rate will change. You
Value = 1680 cannot use cashflows from part a.

Problem 2
MV of Equity = 2000
+ Equity Options 100
Value of Equity 2100
+ Debt 1000
- Cash 500
Value of operating assets 2600

Problem 3
a.
PE Ratio for the firm = 32
Expected growth rate = 17.30
b.
PE Ratio = 42.45 ! 12.13 + 1.56 (24) - 3.56 (2)
PEG ratio = 1.76875 ! 42.45/24
Problem 1
Return on capital on existing assets = 10%
Reinvestment rate = 0.7
a. Expected growth over next 5 years = ROC on new investments * Reinvestment rate + Growth from improved efficiency
= (15%)(.70) +(1+ (.15-.10)/.10)^(1/5)-1
18.95%
b. Portion due to improved efficiency
New Investment growth = 15% *.7 = 10.50%
Growth due to improved efficiency = .1895-.105 = 8.45%

Problem 2
a. Reinvestment rate in perpetuity = g/ rOC = 4/12 = 33.33% ! Don't forget this
Terminal value = 250 (1-.333)/(.09 - .04) = $3,333.33 ! This income is already in year 6. Yo
b. If no excess returns, return on capital = 9%
Reinvestment rate in stable growth = 4/9 = 44.44%
Terminal value = 250 (1-.4444)/(.09-.04) = $2,777.78
Value due to excess returns = $555.56 ! 3333-2778

Problem 3
Current PE ratio = 8
Payout ratio = 60%
PE = Payout ratio/ (Cost of equity -g)
8 = .60/(Cost of equity -g) ! You don't need a (1+g) since you have expected income next ye
Cost of equity - g = 7.50%
If the riskfree rate rises by 1% and expected growth is unchanged, r -g = 8.5%
PE = .60/(.085) = 7.06
rowth from improved efficiency

on't forget this

his income is already in year 6. You don't need (1+g)

! There are other ways you could solve this problem

a. You could make the cost of capital 12%
b. You could estimate the present value of the excess returns.

ou have expected income next year

Problem 1
1 2 3 4 Terminal year
Revenues 650 845 1098.5 1428.05 1470.8915
Op Margin -5% 0% 5% 10% 10%
EBIT -32.5 0 54.925 142.805 147.08915
Taxes 0 0 0 29.122 58.83566 ! Remember to adjust your tax rate t
EBIT(1-t) -32.5 0 54.925 113.683 88.25349
- Reinvestmen $60.00 $78.00 $101.40 $131.82 26.476047 ! Reinvestment in stable growth = g/
FCFF -$92.50 -$78.00 -$46.48 -$18.14 61.777443
Terminal value $686.42 ! Use the new cost of capital to comp
PV -$80.43 -$58.98 -$30.56 $382.09 ! Use a 15% discount rate to discoun
Value of equit $212.12 ! Discount back the cashflows at 15%….

Value per shar $15.81 ! (212.12+25)/(10+5) Add the exercise proceeds to the numerator and divide by fully dil

Problem 2
a. EV/EBITDA for parent company alone
Market value of equity = 2000
+ Debt 1200
- Cash 300
Enterprise value before adj= 2900
- 5% of Equity of Abigail = 250 ! Subtract out the 5% of market value of equity in Abigail
- 60% of Nuveen equity = 792 ! Minority interest = 240; Book value of equity = 600; Market value of equity = 2
- 100% of Nuveen debt = 300 ! Debt is consolidated; Hence you need to subtract out 100% of Nuveen's debt
Enterprise value after adj = 1558

EBITDA for Hollywood Holdin 800

- 100% of EBITDA of Nuveen 400 ! The EBITDA of Abigail does not show up in the parent company but 100% of Nu
EBITDA of parent company = 400

EV/EBITDA = 3.895
emember to adjust your tax rate to 40% in year 5; NOLs are gone….

einvestment in stable growth = g/ROC =3%/10% = 30%

se the new cost of capital to compute the terminal value

se a 15% discount rate to discount the cashflows and the terminal value

e numerator and divide by fully diluted number of shares

= 600; Market value of equity = 2.2*600 = 1320

ract out 100% of Nuveen's debt

e parent company but 100% of Nuveen's EBITDA does

Problem 1
Most Recent 1 2
Revenues $100.00 $120.00 $124.80
EBIT (1-t) $5.00 $12.00 $12.48 You have to estimate the cash
- Net Cap ex $6.00 $4.16 terminal value based upon es
FCFF $6.00 $8.32
Terminal value $138.67
Value today $131.52

Problem 2
Value of operating assets = 1000
+ Cash & Mkt securities 150 The operating income does not include income from cash h
+ Minority passive holdings 200 The income from minority passive investments is also not s
- Minority interests 240 The minority interests represent 40% of the Ajax Leasing th
- Debt 400 Debt has to be netted out. Since you are doing a consolidte
Value of Equity 710
- Value of options 60 Subtract out the value of the equity options to get to value
Value of equity in stock 650
Value per share = 32.5 ! Divide by actual number of shares outstanding

Problem 3
a. PE ratio for Vortex = 12
PEG ratio for Vortex = 1.2
PEG ratio for sector = 1.25
Vortex undervaluation = 4.17% ! (.05/1.20)

b. Vortex may be riskier than the sector. (None of the other explanations are consistent with a lower PEG ratio)

c. ROE = 12%
Payout ratio - first 5 years = 0.166666667 ! Payout ratio = 1 - g/ROE This is the key step. You have
Payout ratio - perpetuity = 75.00% your algebra.

Fundamental PE = 14.33308445 ! I used the 2-stage model for the PE ratio. You cannot use
Fundamental PEG ratio = 1.433308445 ! Divide by the 10% growth rate.
u have to estimate the cashflows for next year first and then compute the
minal value based upon estimated cashflow in year 2.

nclude income from cash holdings. So, you have to add it on. The interest rate is a decoy and does not play a role in the valuation.
ve investments is also not shown in operating income. (it shows up below the operating income line). Add estimated market value = 80 *
40% of the Ajax Leasing that you do not own. Since you counted a 100% in your operating income, you have to subtract estimated mar
you are doing a consolidted valuation, it does not matter even if some of this debt belongs to Ajax Leasing

uity options to get to value of common stock.

er PEG ratio)

s is the key step. You have to compute the payout ratio first before you can use the equation. I was very, very easygoing about

e PE ratio. You cannot use the stable growth model, since you have high growth.
t play a role in the valuation.
Add estimated market value = 80 *2.5
ou have to subtract estimated market value: 120* 2

ry, very easygoing about

Problem 1
Total equity value estimated by analyst = 140
+ Value of minority interest = 20
Total firm value estimated by analyst = 160

Analyst asssumed stable growth rate of 3%, cost of capital of 10% and return on capital of 10%
Reinvestment rate assumed by analyst = 0.3 ! G/ROC
Firm value = 160 = FCFF / (.10- .03)
FCFF = 11.2
After-tax operating income = 16 ! FCFF/ (1- Reinvestment Rate)

After-tax operating income at Nova = 4 ! 25% of firm's consolidated operating income

Reinvestment rate for Nova = 0.25 ! Growth rate/ Nova's return on capital
Value of Nova = 60 ! After tax operating income (1 - Reinvestment Ra
Value of 50% stake in Nova = 30

Springfleld's operating income = 12 ! 75% of firm's consolidated operating income

Springfield's value = 120 ! Use Springfield's cost of capital and reinvestmen
+ Value of 50% stake in Nova = 30 ! Half of 60 from above
Correct value of equity in Springfield = 150
Corect value of equity per share = 15

Problem 2

a. There were two inconsistent multiples and you got full credit for picking either.
The first was enterprise value/ net income from continuing operations. The word operations here is misleading; what matte
The second was market value of equity/ cable subscribers ! Subscribers generate revenue for the firm and n
b. Low EV/EBITDA, Low Tax Rate, High ROC
c. Bank A will be able to pay out more of its earnings as dividends since it has a higher ROE. It should have the higher PE.
d. Stocks with very low growth rates will tend to have very high PEG ratios

Problem 3
ROE = 20%
Cost of equity = 12%
Price to Book Ratio = 2

You could also value this company as a dividend discount model

Value of equity = 100 ! Value of stock = 10 *(1-.04/.2)/(.12-.04)
Price to book ratio = 2 ! 100/50
nsolidated operating income
va's return on capital
ng income (1 - Reinvestment Rate)/ (Cost of capital - g)

nsolidated operating income

s cost of capital and reinvestment rate: 12 (1-.3)/(.10-.03)

here is misleading; what matters is that net income is to equity investors

erate revenue for the firm and not just for equity investors

It should have the higher PE.

Problem 1
Current Reinvestment Rate = 50.00% ! (250 - 100 + 50)/400
Current return on capital 8.00% ! 400/5000
Expected growth rate = 30%
(ROC - 8%)/8% + ROC * .50 = 30%
Solve for ROC, ROC = 10%

Problem 2
1 2 3
Net Income 150 165 181.5
FCFE 50 55 60.5
Expected Growth rate in net income = 10.00%
Equity Reinvestment Rate = 66.67% ! 1- FCFE/ Net Income
Return on equity = g/ Reinvestment rate 15.00%

Growth rate in stable growth = 3%

Equity reinvestment rate in stable growth 20.00% ! G/ ROE
FCFE in year 4 = 149.556 ! 181.5 (1.03) (1-.20)
Terminal value of equity = 2991.12

Problem 3
Market value of equity = 500 ! Since you are given the market value of common
+ Equity options 100 equity, you have to reverse the process (and the signs)
- Cash 150 to get to value of operating assets.
+ Debt 300
Market's assessment of value of operatin 750

Problem 4
Value of equity in VRW = 880 ! Value of operating assets + Cash - Debt
Value of equity in Centaur Steel = 620
Value of 60% stake = 372
Total value of equity in VRW = 1252
t value of common
process (and the signs)
Problem 1
1 2 3
Revenues $1,000 $1,030 $1,061 Grading scale -Part a
Operating Margin -5.00% 1.00% 5.00% a. Did not use year 4 num
EBIT -$50.00 $10.30 $53.05 b. Did not compute reinve
Tax rate 0% 0% 40% c. Wrong cost of capital: -
1 2 3 4 d. Mechanical errors: -0.5
EBIT -$50.00 $10.30 $53.05 $54.64
EBIT (1-t) -$50.00 $10.30 $47.71 $32.78
Reinvestment 0 0 0 9.834543 ! Reinvestment rate = g/
FCFF -$50.00 $10.30 $47.71 $22.95
Terminal value $327.82 Terminal value cost of cap
PV -$44.64 $8.21 $267.29 ! Dicount back all cashflo
Nol $50.00 $39.70 $0.00
Value of firm = $230.86
+ Cash $25.00 Grading scale: Part b
- Debt $100.00 a. Used wrong cost of capit
Value of equity $155.86 b. Cash incorrectely treate
Value per share = $15.59 c. Debt incorrectly treated
d. Mechanical errors: -0.5
Reinvestment Rate = g/ ROC = 3/10 = 30.00%

c. Price of bond = 600

Setting up the problem a. Probability of default n
600 = 1000 (1- probability of distress)/ 1.05^3 b. Mechanical errors: -0.5
Probability of distress = 30.54% c. Value of equity per sha
Value of equity per share = $10.83 ! 15.59*(1-.3054)

Problem 2
a. Value of Zookin's operating assets = 1250
b. Value of equity = 1250 + 250 + 250 = 1750
c. Treasury stock approach = (1750 + 10*5)/ (50+10) = $30.00
d. Overstate the value per share. In the treasury stock appraoch, we value options at exercise value. Th
ading scale -Part a
Did not use year 4 num
Did not compute reinve
Wrong cost of capital: -
Mechanical errors: -0.5

einvestment rate = g/

rminal value cost of cap

Dicount back all cashflo

ading scale: Part b

Used wrong cost of capit
Cash incorrectely treate
Debt incorrectly treated
Mechanical errors: -0.5

Probability of default n
Mechanical errors: -0.5
Value of equity per sha

All or nothing
All of nothing
Mechancal error: -0.5
s at exercise value. Th
Problem 1
Return on capital = 6.00%
Expected growth rate = 3%
Cost of capital = 10%

Reinvestment rate = 50.00%

FCFF next year = $9.27 ! I gave full credit even if you missed the (1+g)
Value of operating assets = $132.43
+ Cash $25.00
- Debt $50.00
- Minority interests $40.00 ! Replace book value of minority interest with estimated market value
Value of equity = $67.43

Prob lem 2
1 2 3
Net Income -10 -5 10
- Reinvestment 10 5 5
= FCFE -20 -10 5
Cost of equity 20% 16% 12%

a. Terminal value
Return on equity = 12%
Expected growth rate = 4%
Reinvestment rate = 33.33%
Net income in year 4 = $10.40
Reinvestment in year 4 = $3.47
FCFE in year 4 = $6.93
Terminal value of equity = $86.67 ! The reinvestment rate has to be re-estimated with ROE = Cost of equ

b. Value of equity today

1 2 3
FCFE -$20.00 -$10.00 $5.00
Terminal value $86.67
Compounded cost of equity 1.2 1.392 1.55904 ! Use compounded cost of equity since r c
Present value -$16.67 -$7.18 $58.80
Value of equity today = $34.95
Exercise proceeds = $4.00 ! Exercise price * 2
Number of shares = 12.00 ! Includes options but not expected future share issues
Value per share = $3.25
 ! Failed to estimate reinvestment; -1 point

! Minority interest miscalculated: - 1 point

! Other errors: -0.5 point

estimated market value

! Reinvestmeent rate not computed: - 1 pt

with ROE = Cost of equtiy

! No compounded cost of equity: -1 point

d cost of equity since r changes

! Double counted shares: -1 point

! Did not compute exercise value: -1 point
Problem 1
Year Current 1 2 3
Expected growth 8% 8% 8%
EBIT (1-t) $300.00 $324.00 $349.92 $377.91
+ Depreciation $50.00 $54.00 $58.32 $62.99
- Cap Ex $175.00 $189.00 $204.12 $220.45
- Change in WC $75.00 $81.00 $87.48 $94.48
FCFF $100.00 $108.00 $116.64 $125.97

a. Reinvestment rate = 66.67% ! (Net Cap Ex + Change in WC)/ EBIT (1-t)

Growth rate = 8.00%
Return on capital = 12.00%
b.
Reinvestment rate = 33.33% ! g/ ROC ! Cashflows grow 4% a year forever after ye
FCFF in year 4 = $262.02 ! 377.91 (1.04) (1-.33) the reinvstment rate has to be reestimated.
Terminal value $4,367.00 ! 262.02/(.10-.04)
c. & d.
FCFF $108.00 $116.64 $4,492.97
Cost of capital 12% 11% 10%
Cumulated WACC 1.12 1.2432 1.36752 ! Discount at cumulated WAC
Present value $96.43 $93.82 $3,285.49
Value of firm $3,475.74
+ Cash 400
- Debt 1000 I also gave full credit if you used the treasury stock approa
- Minority interest 500 ! 250 * 2 Add exercise value of $ 400 million (20*20 to numerator)
Value of equity $2,375.74 and divide by 100 million shares
Value of options 200
Value of equity in common stock $2,175.74
Value per shaer $27.20

e.
False. (The cash wll be discounted only if investstor expect the firm to waste the cash.
This firm has a return on captial > Cost of captial. I would expect investors to trust the
management of this firm.

f.
EBIT (1-t) of diversted stores = $30.00
Cost of capital = 10%
Value of stores = $300.00 ! With no growth, we can assume EBIT (1-t) = FCFF
Divestiture proceeds = 250
Net effect on value = -$50.00 ! Sold for less than these stores are worth
Effect on value/share = -$0.63 ! Value per share will decrease
4% a year forever after year 5, but if the return on capital stays at 12%,
ate has to be reestimated.
! Used cash flow in year 3 to growt at 4%: -1 point
! Did not use 10% as discount rate: -0.5 point

! Discounted at year-specific cost of capital: -0.5 point

iscount at cumulated WACC ! Mistake on minority interest: -0.5 to -1 point
! Other errors: -0.5 point

the treasury stock approach. ! Used weird combinatiions of treasury stock and option
on (20*20 to numerator) approaches: -0.5 to -1 point

! ALL OR NOTHING

! Estimated a reinvstment even though growth was zero: -0.5 top -1 point
e EBIT (1-t) = FCFF ! Did not net out proceeds: -0.5 point
top -1 point
Problem 1
1 2 3 Terminal year
EBIT -$100.00 $100.00 $150.00 154.5 ! Ignored NOL: -1 point
Taxes $0.00 $0.00 $40.00 61.8 ! Failed to accumulate losses: -0.5 points
EBIT (1-t) -$100.00 $100.00 $110.00 92.7 ! Did not compute FCFF: -1 point
Reinvestment $100.00 $150.00 $50.00 23.175
FCFF -$200.00 -$50.00 $60.00 69.525
Terminal value $993.21
Cumulated Cost 1.1500 1.2880 1.4168 ! Did not cumulate discount rates: -1 point
PV -$173.91 -$38.82 $743.38
NOL $150.00 $50.00 $0.00

Capital investe $572.50 $722.50 $772.50 ! Did not compute ROC in year 3: -1 point
! Errors on reinvestment rate: -1 point
Return on capital in terminal year = 12.00% ! Errors on terminal value computation: -0.5 to -1 po
Reinvestment in terminal year = 25.00%

Value of operating assets = $530.64

+ Cash $80.00 ! Did not add cash: -1 point
+ Value of cross holding $100.00 40*2.5 ! Did not compute minority holding value: -1 point
- Expected lawsuit liability $25.00 ! .25*100 ! Did not subtract out lawsuit liability: -1 point
Value of equity $685.64

Value of equity = $685.64 ! Any mistake: -1 point

+ Exercise proceeds $60.00
/ Number of diluted shares 110
Value per share today = $6.78
ulate losses: -0.5 points
e FCFF: -1 point

e discount rates: -1 point

e ROC in year 3: -1 point

stment rate: -1 point
al value computation: -0.5 to -1 point

e minority holding value: -1 point

out lawsuit liability: -1 point
 Year 1 Year 2 Year 3
Revenues $150 $160 $180
EBIT (1-t) -$15 $15 $25
+ Depreciation $15 $20 $25
- Cap EX $5 $25 $40
FCFF -$5 $10 $10 Grading notes
Cost of capital 14% 12% 10%
a. PV of cash flows for first 3 years =
Cumulated Cost of capital 1.1400 1.2768 1.4045 ! Discount at t ! Did not cumulate: -1 point
Cash Flow -$5 $10 $10 ! In year 3: 1. Math errors: -0.5 point each
Present Value -$4.39 $7.83 $7.12
Total $10.57

b. Return on capital invested

EBIT (1-t) -$15 $15 $25 ! Capital inves ! All or nothing…. Sorry
Capital invested: end of year $180 $185 $200 Capital invested in year n + (Cap ex - Depr
ROC -8.33% 8.11% 12.50% g/ROC will not work, since ROC is changing

c. Terminal value
Return on capital = 12.50% ! Did not compute reinvestm
Expected growth rate = 3% ! Math errors: -0.5 point each
Reinvestment Rate = 20.0%
Terminal Value 273.3333333 ! 25*1.025* (1-0.2)/(.10-.025)

c. PV of terminal value = 194.6153262 ! Discount back at cumulated cost ! Used book value of debt: -0
Sum of FCFF next 3 years $10.57 ! Did not discount terminal v
Value of opeating assets = $205.18
+ Cash 25
- Debt 75 ! Cannot use book value ina DCF valuation
Value of equity = $155.18
Value per share= $7.76

Problem 2
FCFE value of equity ! Did not compute FCFE valu
FCFE = 120 ! Already next year's number ! Did not set up probability o
Cost of equity = 10% ! Other math errors: -0.5 poi
Value of equity = 2000 120/(.10-.04)
Market value of equity 1500 ! Share price * No of shares
Market value of equity =FCFE value (1- Prob of Natl) + 0 (Prob of Natl)
Probability of nationalization 25%

Problem 3
Expected return = 12.000% ! Riskfree rate + beta (Risk premium) ! All or nothing
Fund's expected return = 10%

Value of $ 1 investment = 0.833333333 ! .10/.12

Discount on fund = 16.67%

Problem 4 ! Used book value of miniori

Value of operating assets = 1500 ! Added minority interest: -1
+ Cash 200 ! Added debt or netted out c
- Debt 300
- MV of minority interests 240
Value of Equity = 1160
id not cumulate: -1 point
th errors: -0.5 point each

ll or nothing…. Sorry
n year n + (Cap ex - Depreciation)
rk, since ROC is changing

id not compute reinvestment rate: -1 point

ath errors: -0.5 point each

sed book value of debt: -0.5 point

id not discount terminal value: -0.5 point

id not compute FCFE value = - 1 point

id not set up probability of nationalization: -1 point
ther math errors: -0.5 point each

ll or nothing

sed book value of miniority interest: -1 point

dded minority interest: -1 point
dded debt or netted out cash: -0.5 each
a.
Expected EBIT (1-t) = 60 ! Did not compute reinvestment: -1 point
Capital invested = 1000 ! Other errors: -0.5 point each
Return on capital = 6%
Cost of capital = 10%

Expected growth rate = 2%

Expected Reinvestment rate = 33.33%

Value of operating assets = 500

b. To value cash,
Assuming that the cash does not get wasted
Probability of happening = 40% ! Did not value cash right under "not wasting" scenario: -0
Value of cash = 100 ! Did not value cash right under "wasting" scenario: -0.5 to
Assuming that cash gets wasted on projects making 6% (cost of ca! Did not apply probabilities: -0.5 point
Probablity of happening = 60%
Value of cash = 60
Expected value of cash = 76

Problem 2
Value of operating assets = 1200
- Estimated value of minority interes 125 ! 25% of Value of subsidiary = 40/(.10-.02) = 500
+ Cash 100
- Debt 300 ! Assuming that Lonza has no debt or cash
Value of equity 875
- Value of equity options 100 ! Value of options =20 *5
Value of equity in common stock 775
Value per share = 7.75 ! Divide by 100 million shares

Problem 3
Value of Drake Drugs operating asset 1000
Expected growth rate = 2%
Cost of capital = 10%
Imputed FCFF next year = 80 ! 1000 = FCFF next year/ (Cost of capital -g)
Imputed Reinvestment Rate= 10.0% ! Growth rate/ ROC

When you capitalize R&D, neither FCFF nor cost of capital should change Some of you did try to back out the EBIT (1-
FCFF = 80 Pre-R&D
Cost of capital = 10% EBIT (1-t) = 88.88888889
The R&D does affect the reinvestment rate and ROC Reinvestment 8.888888889
Reinvestment rate = 20.00% FCFF 80
Return on capital = 12.50% Post R&D adjustment
Expected growth rate = 2.50% EBIT (1-t) - 88.89 + Current year's R&D -
Reinvestmetn 8.89 + Current year's R&D - R
Corrected value of operating assets= 1066.666667 FCFF 80
Value increases by $66.67 million
"not wasting" scenario: -0.5 point
"wasting" scenario: -0.5 to -1 point

! Error on valuing minority interests: -0.5 to -1 point

! Added option value to value instead of subtracting: -0.5 point
! Adjusted number of shares for options: -0.5 point
! Other errors: -0.5 point each

You cannot use the treasury stock approach since you do not have the exercise price of the options.
All you have is the value per option.

! Did not reestimate the growth rate: -1 point (If you use 2% growth and a 20% reinvesment rate, you
are being internally inconsistent)
! Left EBIT (1-t) at pre-adjustment level: -0.5 to -1 point
! Other errors: -0.5 point each

ry to back out the EBIT (1-t) from the FCFF

! 80.9

89 + Current year's R&D - R&D amortization

9 + Current year's R&D - R&D amortization
nt rate, you
Problem 1
1 2 3 4 5
Revenues (in millions) $1,020.00 $1,040.40 $1,061.21 $1,082.43 $1,104.08
Pre­tax Operating margin ­3.00% ­1.00% 2.00% 5.00% 8.00%
EBIT ($30.60) ($10.40) $21.22 $54.12 $88.33
Taxes 0 0 0 $1.74 $35.33
EBIT (1­t) ($30.60) ($10.40) $21.22 $52.38 $53.00
Reinvestment $10.00 $10.20 $10.40 $10.61 $10.82
FCFF ($40.60) ($20.60) $10.82 $41.77 $42.17

NOL at end of year ($60.60) ($71.00) ($49.78) $4.34 $92.67

Problem 2
Let the intrinsic value of the operating assets be X

Value of Operating assets X

+ Cash 100
Value of firm 1300
- Debt 300
Value of equity 1000
- Value of options 100
Value of shares traded 900

Solving for X
Value of operating assets 1200

1200 = After-tax OI (1- 2%/20%) / (.10-.02)

Solving for After-tax OI $106.67 ! Full credit if you put (1+g) in here and solved

Problem 3
Approach 1: Value June parent and add 60% of value of Vellum
Juno (consoli Vellum Juno (Parent)
Operating income (after­tax) $110  $20  $90
Book Equity $1,000  $100  $900
Debt $225  $50  $175
Cash $100  $25  $75

Invested Capital $125 $1,000

Return on capital 16.00% 9.00% ! Full credit even if you did not net out cash
Expected growth rate 2.00% 2.00%
Reinvestment Rate 12.50% 22.22%
Cost of capital 10.00% 10.00%
Value of business 218.75 875
 + Cash $25 $75
 ­ Debt $50 $175
Value of equity $194 $775
Value of equity in Juno = 775 + 0.6 (194) = $891.25
Value of equity per share = $8.91

Approach 2: Value June consolidated and subtract out 40% of equity value in Vellum (minority interests)

Juno (consoli Vellum
Operating income (after­tax) $110  $20 
Book Equity $1,000  $100 
Debt $225  $50 
Cash $100  $25 

Invested Capital $1,125 $125

Return on capital 9.78% 16.00%
Expected growth rate 2.00% 2.00%
Reinvestment Rate 20.45% 12.50%
Cost of capital 10.00% 10.00%
Value of business 1093.75 218.75
 + Cash $100 $25
 ­ Debt $225 $50
Value of equity $969 $194

Value of equity in Juno = 969 ­ 0.4 (194) = $891.25
Value of equity per share = $8.91
 Grading templage

1. Error on NOL carry forward: -1 point

2. Error on reinvestment number: -1 point
3. Other errors: -0.5 point each

1. Value of the operating assets wrong: -1 point

2. Did not compute reinvestment rate: -1 point
3. Other errors: -0.5 point each

1. Computed ROC using book equity alone: -1 point

2. Did not compute reinvestment rate: -1 point
3. Mixed up add/subtract minority holding/interest: -1 point
4. Did not compute equity value of sub: -0.5 point
5. Other errors: -0.5 point each

if you did not net out cash

minority interests)
Problem 1
1 2 3 4 5
Revenues $500 $750 $1,000 $1,200 $1,250
Operating Income after taxes $10 $23 $35 $40 $50
Reinvestment $30 $25 $25 $20 $20
FCFF -$20 -$3 $10 $20 $30
Cost of capital 12% 11% 10% 9% 8%
Invested capital $410 $435 $460 $480 $500
Return on capital 2.44% 5.17% 7.61% 8.33% 10.00%
Reinvestment rate = 30.0%
Terminal value = $721.00
Discount factor for year 5 1.609844544 ! (1.12)(1.11)(1.10)(1.09)(1.08)
Present value of terminal value $447.87

Problem 2
Limca (Parent)LightEat
Value of the operating assets $1,500.00 $600.00
Debt $500.00 $300.00
Cash $200.00 $100.00
Number of shares 100.00 50.00

Value of equity (independent) $1,200.00 $400.00

Value of equity with cross holdings $1,500.00
Value of equity per share = $15.00

Problem 3
Market value of equity = 600
+ Debt 250
- Cash 100
Value of operating assets 750
Cost of capital 9%
Growth rate 3%
Reinvestment rate = 33.33%
750 = AT Op Inc (1- .33)/ (.09-.03)
After-tax operating income $67.50
After-tax operating margin 6.75% ! If you use (1+g), answer = 6.55%

Problem 4
Value with existing management = $250.00
Return on capital (existing) = 5.00%
Return on capital (new) = 10%
New reinvestment rate = 20.0%
Value with new management = $333.33
Expected value = $283.33
Grading template
1. Wrong return on capital in year 5 = -1 point
2. Did not discount back to present or used wrong discount factor: -1 point
3. Other math errors: -1/2 point

1. Did not value Limca correctly: -1 point

2. Did not reflect value of LightEat: -1 point
3. Math errors: -1/2 point

1. Did not compute reinvestment rate: -1 point

2. Used wrong value of operating assets: -1 point
3. Math errors: -1/2 point

1. Error on status quo valuation: -1 point

2. Error on optimal valuation: -1 point
3. Did not compute return on capital for status quo: -1 point
4. Math error: -1/2 point
Problem 1
Current Revenues = $10.00
Current Invested Capital = $5.00
Current Sales to Capital = 2.00
1 2 3
Expected revenues $40.00 $75.00 $100.00
Pre-tax Operating Income -$10.00 $10.00 $30.00
NOL at start of year 20 $30 20
Taxes paid 0 0 $3
After-tax Operating Income -$10 $10 $28
- Reinvestment $15.00 $17.50 $12.50
FCFF -$25.00 -$7.50 $15.00

Invested Capital $20.00 $37.50 $50.00

Pre-tax return on capital -50.00% 26.67% 60.00%

Problem 2
After-tax operating income $25.00
Expected growth rate = 2%
Return on capital = 10%
Reinvestment Rate 20.0%
Expected FCFF = $20.00
Cost of capital = 7%
Enterprise Value = 400
- Net Debt 100
- 25% of TrueSmoke Equity 50
Value of equity = 250
- Value of options 25
Value of common stock 225
Number of shares 25
Value per share $9.00

Problem 3
Value of Domino Media = 500
- Debt 350
+ Cash 50
Value of equity 200
Value per share (going concern) = 20
Price per share = 15 ! Value per share (going concern) (1- Prob (Default)) + Value per shar
Probability of bankruptcy 25% ! 15 = 20 (X) + 0(1-X)
 Grading Guideline

1. Sales to Capital ratio incorrect: -/2 to 1 point

2. Taxes incorrect: -1 point
3. Reinvestment incorrect: -1 point

1. Did not compute reinvestment: -1 point

2. Value of the firm incorrect: -1/2 to -1 point
3. Did not deal correctly with TrueSmoke equity value: -1 point
4. Dealt with options incorrectly: -1 point

1. Incorrect value estimate for going concern: -1 point

2. Errors getting from firm value to equity value: -1 point
3. Error in backing out probability of default: -1 point

n) (1- Prob (Default)) + Value per share (default) (Prob Default)

Problem 1
Base year 1 2 3
Expected growth 6.00% 6.00% 6.00%
EBIT (1-t) $100.00 $106.00 $112.36 $119.10
- Reinvestment $40.00 $42.40 $44.94 $47.64
FCFF $60.00 $63.60 $67.42 $71.46

Reinvestment rate = 40.00%

Expected growth rate = 6.00%
Return on capital = 15.00%

In year 4
Expected growth rate = 3%
Return on capital = 15.00%
Reinvestment rate = 20.0%

EBIT (1-t) = $122.67

- Reinvestment = $24.53
FCFF $98.14

Terminal value = $1,962.79

Problem 2
PV of FCFF @ Cash Debt
Xena (consolidated) $1,500.00 $300.00 $500.00
Clio $750.00 $200.00 $150.00
Lomax $1,000.00 $100.00 $200.00

Approach 1: Value as separate companies

Equity value
Xena (parent) $500.00 $200.00 $300.00 $400.00
Clio $750.00 $200.00 $150.00 $800.00
Lomax $1,000.00 $100.00 $200.00 $900.00
Value of equity in Xena

Approach 2: Value consolidated & net out minority interests

Xena (consolidated) $1,500.00 $300.00 $500.00 $1,300.00
Clio $750.00 $200.00 $150.00 $800.00
Net out minority interests (25%) of Lomax
Lomax $1,000.00 $100.00 $200.00 $900.00
Value of equity in Xena

Problem 3
Most recent 1 2 3
Net Income $100.00 $110.00 $121.00 $133.10
Regulatory capital $1,000.00 $1,050.00 $1,102.50 $1,157.63
Change in regulatory capital $50.00 $52.50 $55.13
FCFE $60.00 $68.50 $77.98
ROE 10.48% 10.98% 11.50%

Terminal value calculation

Net Income in year 4 = 137.093
ROE in year 4 = 11.50%
Expected growth rate = 3%
Payout ratio in year 4 = 73.91%
FCFE in year 4 $101.32
Terminal value = $2,026.45
 Grading template
Year 41.(and
Used
beyond)
after-tax OI as FCFF: -2 points
3.00% 2. Used RR from first 3 years as terminal RR: -1.5 points
$122.67 3. Error on computing ROC: -1 point
4. Used FCFF from year 3 as earnings: -1/2 point

1. Errors on computing equity values: -1/2 each

2. Subtracted Clio value instead of adding: -1 point
3. Added Minority Interest instead of subtracting: -1 pont
4. Other errors: -1/2 to -1 point

Ownership Value of ownerships

100% $400.00
25% $200.00
75% $675.00
$1,275.00

100% $1,300.00
25% $200.00
$1,500.00
25% $225.00
$1,275.00

1. Computed reinvestment from ROE: -1 point

2. Math errors: -1/2 point

1. Used FCFE from year 3 as earnings: -1/2 point

2. Did not compute ROE: -1.5 points
3. Error on computing ROE: -1 point
4. Computed book value of equity: -1.5 points
Problem 1
PV of blockbuster drug at the end of ye $7,606.08
PV of blockbuster drug today = $4,722.78
Probability that it will be approved = 60%
Value of company today = $2,833.67
Number of shares = 100
Value per share = $28.34

Problem 2
Intrinsic value of operating assets = 500
+ Cash 50 ! No discount because company earns its costs of capital
- Debt 100 ! Only interest bearing debt. Don't double count accounts payable
- Expected lawsuit payout 40 ! 25% of $160 million
- 20% of Electra Retail 80 ! Counted entire value in your DCF
Value of equity 330
- Value of equity options 10
Value of equity in common stock 320
Number of shares outstanding 70
Value per share = $4.57

Problem 3
Base 1 2 3 Terminal year
Revenues $500.00 $525.00 $551.25 $578.81 $596.18
EBITDA Margin 2.50% 5.00% 10.00% 20.00%
EBITDA $12.50 $26.25 $55.13 $115.76
DA $40.00 $40.00 $40.00 $40.00
EBIT $27.50 $13.75 $15.13 $75.76 $77.28
Taxes $0.00 $0.00 $14.86
EBIT(1-t) $13.75 $15.13 $60.91
+ DA $40.00 $40.00 $40.00
- Cap Ex $0.00 $0.00 $0.00
- Chg in WC $10.00 $10.00 $10.00
FCFF $36.25 $65.13 $110.91
Terminal Value $579.58
NOL $40.00 $53.75 $38.63 $0.00
Tax savings 0 $6.05 $9.95
PV at 12% $4.82 $7.08

Terminal value
Reinvestment rate = 0.25
EBIT (1-t) in terminal year = $46.37
FCFF in terminal year = $34.77
Terminal value = $579.58

Value of NOL = $11.91 See above

 Grading template
1. PV of blockbuster drug incorrect: -1/2 point to -1 point
2. Did not discount back 5 years: -1/2 point
3. Did not adjust for probability of failure: -1/2 point
4. Other math errors: -1/2 point

nt accounts payable

1. Did not add cash: -1/2 point

2. Wrong debt subtracted (or missed); -1/2 point
3. Lawsuit dealt with incorrectly: -1/2 point
4. Minority interest incorrectly dealt with: -1 pont
5. Wrong adjustment for equity options: -1/2 to -1 point
(I gave full credit for the treasury stock approach, where you add the exercise value of $20 million and divide

1. Did not track NOL correctly: -1/2 to -1 point

2. Did not estimate EBIT correctly: -1/2 to -1 point
3. Did not add back DA: -1/2 point
4. Did not adjust for WC correctly: -1/2 point

1. Did not recompute CF in terminal year: -1 point

2. Did not compute reinvestment rate correctly: -1/2 to -1 point
3. Math errors: -1/2 point each

! If you were withing shooting distance of $16 milion: -1/2 point

If you ended up within shooting distance of $40 million: -1 point
If you ended up with values greater than $40 million: -1.5 point
se value of $20 million and divide by 75 million shares)
Problem 1
Veritas Haversack Samson
Value of operating assets $ 1,800.00 $ 900.00 $ 800.00
+ Cash $ 200.00 $ 100.00 $ 100.00
- Debt $ 500.00 $ 200.00 $ 300.00
Value of equity $ 1,500.00 $ 800.00 $ 600.00

Value of equity in Veritas $ 1,500.00

+ 10% of Haversack Equity $ 80.00
- 25% of Samson Equity $ 150.00
Value of equity in Veritas $ 1,430.00
# Shares 100
Value per share $ 14.30

Problem 2
Estimated value = $ 1,200.00
Expected growth rate = 1.50%
Cost of capital = 7.50%
Expected CF (used) $ 72.00

Return on invested Capital = 12% ! 7.5% + 4.5%

Reinvestment Rate = 12.500%
Corrected CF $ 63.00
Corrected Value = $ 1,050.00

Problem 3
Estimated value of equity = $ 1,000.00
- Value of options $ 100.00
Value of equity in common stock $ 900.00
# Common shares outstanding 100.00
Value per share $ 9.00

I don't like the treasury stock approach, but I gave full credit if you used it.
Estimated value of equity $ 1,000.00
+ Exercise proceeds of option $ 150.00
Total equity value $ 1,150.00
Fully Diluted shares 125.00
Value per share $ 9.20

Problem 4
Last year 1 2 3
Revenues $ 500 $ 1,000 $ 2,000 $ 3,000
Operating Margin -60% -10% -5% 10%
Sales/Capital Ratio 2.00 2.00 2.00
Cost of capital 15% 12% 10%

1 2 3
Revenues $ 1,000 $ 2,000 $ 3,000
Operating Income $ (100) $ (100) $ 300
Taxes 0 0 $ 20 ! NOL = 50 + 100+100
Operating Income after tax $ (100) $ (100) $ 280
Reinvestment 250 500 500
FCFF $ (350) $ (600) $ (220)
Cumulated Cost of capital 115% 1.288 1.4168
Present value $ (304.35) $ (465.84) $ (155.28)
 Grading Template

1. Mistake on adding back 10% of minority holding: -1 point

2. Mistake on subtracting out 25% of majority holding: -1 pont
3. Mixed up enterprise and equity values: -1 point
4. Math error ; -1/2 point

1. Did not back out expected cash flows from value: -1 point
2. Reinvestment not computed correctly: -1 point
3. New valuation done incorrectly: -1/2 to -1 point

1. Value of equity wrong: -1/2 point

2. Used exercise value instead of option value: -1 point
3. Double counted by dividing by the total number of shares outstanding

1. Reinvestment incorrect: -1 point

2. Taxes incorrect: -1 point
OL = 50 + 100+100 3. FCFF incorrect: -1/2 point

1. Did not used cumulated cost of capital: -1 point