PRACTICE PROBLEMS For

Financial Analysis and Valuation

Professor L. LEVITIN

FBE 421

Spring 2020
 PRACTICE SETS #1-7

Index

Subject Page

Practice Set #1 – Valuation Concepts and Analysis

Problems 1
Solutions 14

Practice Set #2 – DCF

Problems 22
Solutions 26

Practice Set #3 – Comparable Companies

Problems 36
Solutions 42

Practice Set #4 – Mergers and Acquisitions

Problems 49
Solutions 54

Practice Set #5 – Restructuring

Problems 59
Solutions 60

Practice Set #6 – LBOs

Problems 63
Solutions 64

Practice Set #7 – Private Firms

Problems 65
Solutions 66

i
PRACTICE SET #1 – VALUATION
CONCEPTS AND ANALYSIS

PROBLEMS & SOLUTIONS

 PRACTICE SET #1 – VALUATION CONCEPTS AND ANALYSIS
PROBLEMS

Problem 1

You calculated the following numbers from the financial statements for a firm for 2019:

EBIT/Sales 10%
Effective tax rate 40%
Sales/Invested Capital 2.0

What is the firm’s ROIC for 2019?

Problem 2

Assume:

NOPAT – 2019 $ 1,000

Invested Capital
1/1/19 $10,000
12/31/19 $12,000

What is the ROIC for 2019?

Problem 3

Assume:

EBIT $ 1,000
Tax rate 30%

What is NOPAT?

1
Problem 4

Assume the following income statement for X Co. in 2019.

Sales $10,000
CGS 6,000
Oper. Exp. 2,000
Operating income $ 2,000
Tax 800
Net income $ 1,200

Depreciation reported in SCF $ 500

A. What is EBIT?

B. What is EBITDA?

C. What is NOPAT?

Problem 5

A firm reports the following items on its most recent balance sheet:

Short term debt $100

Long term debt 200
Shareholders’ equity 700
Cash 50
Marketable securities 100

Based on this information, what is the book value of the firm’s invested capital?

2
Problem 6

A firm reported the following income statement for 2019 (in millions).

Sales $20,000
Operating expenses 17,000
Restructuring charge 2,000
Operating profit 1,000
Interest expense 300
Interest income 100
Earnings before taxes 800
Income taxes 320
Net income $ 480

Invested capital at end of 2018 was $15,000, and $16,000 end of 2019.

a. What is the EBIT?

b. What is the recurring EBIT?

c. What is the NOPAT?

d. What is the recurring NOPAT?

e. What is recurring EBIT/Sales ratio?

f. What is ROIC for 2019?

g. What is recurring ROIC for 2019?

Problem 7

A firm reports an operating income before tax of $100 million on sales of $1 billion.
Interest expense was $30 million and effective tax rate was 40%. Your analysis of
footnotes to financial statements revealed that included in reported operating income
were the following nonrecurring items:

Start-up costs for new venture $10 million

Merger-related charge $20 million
Gain on disposal of plant $8 million

a. What is recurring EBIT?

b. What is recurring EBIT/Sales ratio?

c. What is recurring NOPAT?

3
Problem 8

Shown below is a matrix showing various spreads between sustainable ROIC and WACC
and growth scenarios:

ROIC ROIC ROIC

> WACC = WACC < WACC
Growth is high
Growth is moderate
Growth is zero

Insert in the above cells:

(1) A letter V if you believe value will be created. If you believe value will be
created in more than one cell, use V-1 for cell indicating most value creation;
V-2 for next most valuation, etc.

(2) A letter N if you believe no value will be created or lost

(3) A letter D if you believe value will be destroyed. If you believe value will be
destroyed in more than one cell, use D-1 for cell indicating most value
destroyed, D-2 for cell indicating less value destroyed, etc.

Problem 9

Name three things a company can do to increase its value. Discuss in terms of ROIC,
WACC, and growth in invested capital.

Problem 10
On your first day of your job as a financial analyst, your boss asks you for cons of the
following financial targets:
1. Return on investment (either ROE or ROIC)
2. Payback since this measures how fast a strategy returns cash flow.
3. Growth in sales or earnings.

4
Problem 11
The financial statements of a clothing manufacturer are shown below.

Balance Sheets (in millions)

      Year Ended     
2019 2018
Cash $ 45 $ 25
Accounts receivable 115 145
Inventories 85 150
Prepaid expenses 15 18
Net fixed assets 195 182
Total Assets $455 $520

Accounts payable $ 90 $110

Notes payable 45 68
Accrued expenses 22 25
Long-term debt 60 50
Shareholders’ equity 238 267
Total Liabilities and
Shareholders’ equity $455 $520

Income Statements (in millions)

2019 2018
Net Sales $675 $800
Cost of goods sold 485 580
Selling, general and admin. exp. 82 100
Depreciation expense 25 27
Operating income $ 83 $ 93
Net interest expense 10 13
Earnings before tax $ 73 $ 80
Income tax expense 23 25
Net income $ 50 $ 55

5
Problem 11 continued

a. Compute invested capital(IC) at end of years 2019 and 2018.

b. Break down invested capital into its operating working capital and
fixed asset components.

2019 2018
Operating working capital
Net Fixed assets _____ _____
IC                       

c. Complete the following

2019 2018
Sales
Operating expenses excluding depreciation _____ _____
EBITDA
Depreciation _____ _____
EBIT
Tax on EBIT _____ _____
NOPAT
Interest expense after tax _____ _____
Net income                       

d. Calculate ROE for 2019.

e. Calculate ROIC for 2019.

f. Calculate operating profit margin for 2019.

g. Assume there are 25 million shares outstanding during 2019 that were
valued at $15 per share at end of 2019. Compute EPS for 2019.

h. What was the P/E multiple at end of 2019?

i. What was the market-to-book ratio at end of 2019?

j. What is FCF for 2019?

6
Problem 12

Shown below is a balance sheet and income statement prepared by an accountant.

Balance Sheet
   2019    2018  
Assets
Cash 30 50
Inventory 400 450
Net PP&E 1,600 1,700
Total 2,030 2,200

Liabilities & Equity

Accounts payable 250 300
Debt (interest-bearing) 450 400
Deferred income taxes 100 100
Common stock and retained earnings 1,230 1,400
Total 2,030 2,200

Income Statement

  2019 
Sales 2,000
Operating costs, excl. depreciation 1,400
Depreciation 50
Operating profit 550
Interest 40
Earnings before tax 510
Tax 204
Net income 306

7
Problem 12 continued

(A) Compute NOPAT

(B) Compute invested capital for 2019 and 2018.
(C) Compute ROIC for 2019.
(D) What is the EBIT/interest ratio for 2019?
(E) What is EBITDA/interest ratio for 2019?
(F) What is FCF for 2019?

Problem 13

Below is selected data for Company Y for 2019:

NOPAT $ 2,000
Invested capital – beginning of year 20,000
Invested capital – end of year 23,000
Net Income 1,500
Shareholders’ equity – beginning of year 12,000
Shareholders’ equity – end of year 14,000

What is the ROIC for 2019?

Problem 14

Rider Co.’s income statement for 2018 and 2019 is shown below:

  2018     2019  
Revenues 5,100 5,400
Operating expenses (3,700) (3,800)
Depreciation (500) (510)
Operating income 900 1,090
Interest income 80 75
Interest expense (250) (260)
Taxes (400) (420)
Net income 330  485 

8
Problem 14 continued

Rider’s summarized balance sheet at year-end 2018 and 2019 is shown below:

  2018     2019  
Cash 2,000 2,200
Inventory 4,000 4,200
Other current assets 1,000 1,200
Net Property, plant and equipment 16,000 16,400
Total Assets 23,000 24,000

Current liabilities (NIBLs) 3,000 3,500

Debt 3,500 3,700
Stockholders’ equity 16,500 16,800
23,000 24,000

A. What is NOPAT for 2019?

B. What is ratio of EBITDA to interest expense 2019?

C. What is ROIC for 2019?

D. What is ROE for 2019?

E. What is debt/capital at end of 2019 (use year-end values to compute).

F. What is net debt/capital at end of 2019 (use year-end values to compute).

9
Problem 15

The following income statement and balance sheet is for a manufacturer of sport
and fashion footwear for 2019.

Income statement (In millions)

Revenues $10,000
Cost of sales 6,000
Gross margin 4,000
Restructuring costs 1,000
Selling and administrative expense 2,000
Interest expense 50
Income before taxes 950
Income taxes 285
Net income 665

Balance Sheet

Assets

(In millions)
2019 2018
Current assets
Cash and equivalents $ 800 $ 600
Short-term investments 400 ---
Accounts receivable 2,100 2,000
Inventories 1,600 1,500
Deferred income taxes 100 200
Prepaid expenses 400 300
Total current assets $5,400 $4,600

Property, plant and equipment, net 1,600 1,500

Intangible assets 400 300
Goodwill 200 100
Deferred income taxes 300 200
Total assets $7,900 $6,700

10
 Problem 15 continued

Liabilities and stockholders’ equity

(in millions)
2019 2018
Current liabilities
Current portion long term debt $ --- $ 200
Notes payable 200 100
Accounts payable 800 600
Accrued liabilities 1,000 1,100
Income taxes payable 100     100
Total current liabilities $2,100 $2,100

Long-term debt 700 600

Deferred income taxes 400 300

Shareholders’ equity 4,700 3,700

______ ______
Total liabilities and shareholders’ equity $7,900 $6,700

A. What is the firm’s invested capital at end of 2018?

B. What is the firm’s recurring ROIC (including goodwill) for 2019?

C. What is the firm’s operating working capital at end of 2018?

11
 PRACTICE SET #1 – VALUATION CONCEPTS AND ANALYSIS
SOLUTIONS

Problem 1
EBIT/sales 10%
NOPAT/Sales 6%

ROIC = NOPAT/sales x Sales/Invested Capital = 6% x 2 = 12%

Problem 2
ROIC = 1,000/11,000 = 9.1%

Problem 3
NOPAT = 1,000 x (1 – 30%) = 700
Problem 4

A. EBIT = 2,000

B. EBITDA = 2,000 + 500 = 2,500

C. NOPAT = EBIT x (1 – t) = 2,000 x 1 – 800/2000

=1,200

Problem 5
IC = 100 + 200 + 700 – 50 – 100 = 850

Problem 6
a. $1,000

b. 1,000 + 2,000 = $3,000

c.. $1,000 x (1 – 320/800) = $600

d. $600 + 2,000 (1 – 40%) = $1,800

or
$3,000 x (1 – 40%) = $1,800

e. $3,000 = 15%
$20,000

f. 600/15,500 = 3.9%

12
 g. 1800/15,500 = 11.6%

Problem 7

a. EBIT reported $100

Start up 10
Merger charge 20
Gain (8)
Recurring EBIT $122

b. Recurring EBIT/sales =   122   = 12.2%

1,000

c. Recurring EBIT x (1 – t) = 122 x (1 – .4) = 73.2

assumes ETR on nonrecurring is same as on recurring items.

Problem 8

ROIC ROIC ROIC

> WACC = WACC < WACC
Growth is high V-1 N D-1
Growth is moderate V-2 N D-2
Growth is zero V-3 N D-3

Problem 9

1. Increase ROIC
2. Decrease WACC
3. Grow IC if ROIC > WACC

Problem 10

1. Can discourage investments that promise returns above cost of capital but below
established goal. Also many investments create value that have bad returns in
early years.
2. No relation to whether return exceeds cost of capital (i.e., has a NPV).
3. No relation to whether return exceeds cost of capital (i.e., has a NPV).

13
Problem 11

a.
2007 2006
Debt 105 118
Equity 238 267
Cash (45) (25)
IC 298 360

Debt includes notes payable and long term debt

b.
2007 2006
Operating working capital 103 178
Net fixed assets 195 182
IC 298 360

Operating W/C
Accounts Receivable 115 145
Inventories 85 150
Prepaid expenses 15 18
Accounts payable (90) (110)
Accrued expense (22) (25
Total 103 178

14
Problem 11 continued

c.
2007 2006
Sales 675 800
Operating expenses excluding depreciation _567 _680
EBITDA 108 120
Depreciation __25 __27
EBIT 83 93
Tax on EBIT 31.5% and 31.3% _ 26 __29
NOPAT 57 64
Interest expense after tax __ 7 ___9
Net income     50      55

d ROE =    50   = 19.8 %

252.5

e. NOPAT (2007) = 83 X (1 - .315) = 57

ROIC = NOPAT/ave. IC = 57/329 = 17.3%

f. 83/675 = 12.3%

g. EPS = $50/25 = $2.00

h $15/$2 = $7.50

i (25 x $15)/238 = 1.6

j. NOPAT – incr. IC = 57 – (298 – 360) = 119

Problem 12

A. NOPAT = EBIT x (1 – t)
= 550 x (1 – 204/510)
= 330

15
Problem 12 continued
B.

2007 2006

Debt 450 400

Equity 1,230 1,400
Cash (30) (50)
IC 1,650 1,750

C. ROIC = NOPAT =   330   = 19.4%

Ave. IC 1,700

D. 550 = 13.75
40

E.( 550 + 50)/40 = 15x

F. NOPAT – Incr. IC = 330 – (1,650 – 1,750) = 430

Problem 13

ROIC = 2,000/21,500 = 9.3%

Problem 14

A. NOPAT = EBIT x 1 – t
= 1,090 x (1 – .464) = 584

Where
t = 420/(1,090 + 75 – 260) = 420/905 = 46.4%

B. EBITDA = 1,090 + 510 = 1,600

EBITDA/interest exp = 1,600/260 = 6.15

C. ROIC = NOPAT/IC = 584/18,150 = 3.2%

NOPAT = 584
IC beginning year = 3,500 + 16,500 – 2,000 = 18,000
IC end year 3,700 + 16,800 – 2,200 = 18,300
Ave. IC = 18,150

16
Problem 14 continued

D. ROE = NI/ave. equity = 485/16,650 = 2.9%

E. Debt/capital = 3,700/20,500 = 18%

F. Net debt/capital = (3,700 – 2,200)/(20,500 – 2,200) = 1,500/18,300 = 8.2%

Problem 15

A. IC = 600 + 200 + 100 + 3,700 – 600 = 4,000

B.
Recurring EBIT = 4,000 – 2,000 = 2,000

Recurring NOPAT = 2,000 x 1 –  285  = 1,400

950

IC(2006) = 4,000 per above

IC(2007) = 700 + 200 + 4,700 – 800 – 400=4,400

Ave/IC = 4,200
Recurring ROIC = 1,400/4,200 = 33.3%

C. Current assets 4,600

– Cash 600
Operating current assets 4,000
Current liabilities 2,100
– Debt (200 + 100) 300
Operating current liabilities 1,800
Operating W/C = 4,000 – 1,800 2,200

17
 PRACTICE SET #2 - DCF

PROBLEMS & SOLUTIONS

 PRACTICE SET #2 - DCF
PROBLEMS

Problem 1

A client makes the following forecast:

Year 1 Year 2 Year 3

NOPAT 10.00 12.00 14.00
Depreciation 2.50 3.00 3.50
Addition to operating working capital 1.00 1.00 1.50
Capital expenditures 5.00 6.00 7.00

Invested capital beginning of year 1 was $134.50. FCF will grow at rate of 5% per year
after year 3. WACC is 10%.

a. Compute FCF for years 1-3.

b. Compute book value of invested capital at end of years 1-3.

c. Compute TV at end of year 3.

Problem 2

Shown below is a forecast of free cash flow for a beverage company. FCF grows after
year 5 of rate of 5% per year. Complete the valuation.

Forecast (in millions)

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
NOPAT 3,700 4,100 4,700 5,500 5,900
Investments in operations 900 1,200 1,200 900 900
FCF 2,800 2,900 3,500 4,600 5,000
Discount rate (1.10)t 1.10 1.210 1.331 1.464 1.611
P.V. of FCF $
P.V. of TV* _____
Enterprise value $
Value nonoperating assets 1,000
Value debt 5,000
Equity value $
Shares outstanding 2,500
Value per share $____
*TV =

21
Problem 3

How does the length of the explicit forecast period affect your estimate of the company’s
value?

Problem 4

You estimate Popeye ‘s FCF at $100 for 2008. FCF is expected to grow forever at 5%.
Popeye’s debt is estimated at $400 at year end 2008, and has 50 outstanding shares.
WACC is 10%. What is the estimated value of Popeye’s equity per share at end of 2008?

Problem 5

Shown below is a 4-year projection for the Tip Top Co.:

Year 1 Year 2 Year 3 Year 4 EBIT

100 120 140 150
Depreciation 20 24 28 30
Capital expenditures 70 65 80 95
Operating w/c increase(decrease) (10) (10) 8 8

After year 4, FCF is expected to grow at a rate of 3%. Tax rate is 40%, WACC is 10%.

(A) Estimate FCF for years 1-4.

B) Estimate the TV at end of year 4.

C) Estimate enterprise value

22
Problem 6

Willy’s Co. generated sales of $3,000 for 2008 and projects the following for 2009:

(1) Sales up 10%

(2) EBIT 20% of sales
(3) Tax rate 40%
(4) Incremental investment in operating working capital will be 10% of increase in sales
(5) Net capital expenditures will be 10% of sales for the year.
(6) Net income margin will be 6%.
(7) Incremental investments in operating working capital and net capital expenditures
assets will be financed with 50% debt. (Note: net capital expenditures are capital
expenditures less depreciation.)

Compute FCF 2009.

Problem 7

Based on the following assumptions for 2009, calculate the 2009 FCF and FCFE for Tar
Co.:
EBIT $600
Depreciation 400
Tax rate 40%
Increase in operating working capital 50
Net capital expenditures 500
Increase in debt 50% of increase in IC
Interest expense 100

23
Problem 8

Willy’s Co. generated sales of $3,000 for 2008 and projects the following for 2009:

(1) Sales up 10%

(2) EBIT 20% of sales
(3) Tax rate 40%
(4) Incremental investment in operating working capital will be 10% of increase in sales
(5) Net capital expenditures will be 40% of increase in sales.
(6) Net income margin will be 6%.
(7) Incremental investments in operating working capital and net capital expenditures
will be financed with 50% debt.

Compute FCFE for 2009.

Problem 9

A firm projects its net cash flow available for debt principal payments and its
debt levels for next 5 years as follows:

Year
   1       2       3       4       5   
EBIT 64 68 90 105 120
Interest expense (36) (36) (37) (32) (28)
Income before tax 28 32 53 73 92
Tax (40%) 11 13 21 29 37
Net income 17 19 32 44 55
Depreciation 180 186 196 210 224
Capital expenditures (169 (189 (105 (129 (119)
) ) ) )
Increase in operating working capital (32 (34 (52 (60)
) ) (45) )
Net cash flow available for debt
principal payments 18) 78 73 100
(4)

Debt beginning of year 600 604 622 544 471

Debt end of year 604 622 544 471 371

24
Problem 9 continued

Note that firm uses all available net cash flows (after interest expense) to pay down
debt each year through year 5. After year 5, interest expense and free cash flow grows
at rate of 3% per year.

Assumptions:

Cost of debt 6%
Unlevered equity (asset) beta 0.8
Long term U.S. government bond rate 4%
Market risk premium 7%
Long-term annual growth rate 3%

You are to value the firm using the APV method of valuation. Calculate interest
expense based on beginning of year balance of debt. Discount interest tax shields at
cost of debt.

Problem 10

Speedy Growth Inc. forecasts revenues of $10,000 in year 1, expecting to grow 20% in year 2,
10% in year 3, and 5% per year thereafter. Other assumptions:

 EBIT margin: 10% in year 1, 15% in year 2, 20% thereafter

 Tax rate 40%
 IC at beginning of year 1 is $5,000 which is 50% of projected revenues for year 1. IC
turnover ratio is expected to remain constant at a level of 2 thereafter
 Debt at beginning of year 1 is $3,000; nonoperating assets are $0.
 Pretax cost of debt: 8%
 WACC: 10%
 Unlevered cost of equity: 11%
 Interest Expense:

Year 1 $300
Year 2 $240
Year 3 $200
After year 3 grows at 5% per year

Calculate value of equity using APV method. Discount interest tax shields at cost of debt.

25
 PRACTICE SET #2 - DCF
SOLUTIONS

Problem 1

a.
Year 1 Year 2 Year 3

NOPAT 10.00 12.00 14.00

Depreciation 2.50 3.00 3.50
Addition to operating working capital (1.00) (1.00) (1.50)
Capital expenditures (5.00) (6.00) (7.00)
FCF 6.50 8.00 9.00

b.
Year 1 Year 2 Year 3
IC beginning of year 134.50 137.50 141.50
Additions (NOPAT – FCF)(1) 3.50 4.00 5.00
IC end of year 137.50 141.50 146.50

c.
TV = FCFt (1 + g) =   9 x 1.05  = 189
WACC – g (.10 - .05)

(1)
Or addition to operating working capital + capital expenditures – depreciation.

26
 Problem 2

Forecast (in millions)

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
NOPAT 3,700 4,100 4,700 5,500 5,900
Investments in operations (900) (1,200) (1,200) (900) (900)
FCF 2,800 2,900 3,500 4,600 5,000
t
Discount rate (1.10) 1.10 1.210 1.331 1.464 1.611
P.V. of FCF $ 13,818 2,545 2,397 2,630 3,142 3,104
P.V. of TV* 65,197
Enterprise Value 79,015
Value nonoperating assets 1,000
Value debt (5,000)
Equity value $75,015
Shares outstanding 2,500
Value per share $ 30.01

*TV = 5,000 x 1.05 = 105,000

(.10 – .05)

PV of TV= 65,197

Problem 3

To the extent ROIC – WACC spread is larger in the explicit forecast period than in the
TV period, the longer the forecast period, the higher the valuation.

Problem 4

Enterprise Value =  100(1.05)  = $2,100

(.10 - .05)

Debt (400)
Equity value $1,700
Shares outstanding 50
Per share value $ 34

27
Problem 5

(A)
Year 1 Year 2 Year 3 Year 4

EBIT 100 120 140 150

Tax (40) (48) (56) (60)
NOPAT 60 72 84 90
Depreciation 20 24 28 30
Capital expenditures (70) (65) (80) (95)
Operating working capital change 10  10  (8) (8)
FCF 20 41 24 17

(B)

TV = FCFt (1 + g)/(WACC – g) = 17 x 1.03/(.10 - .03) = 250.14

(C)

Value FCF
Year 1 18.18
Year 2 33.88
Year 3 18.03
Year 4 11.61
PV of TV (250.14/(1.10)4 170.85
EnterpriseValue 252.55

Problem 6
FCF
Sales (3,000 x 1.10) 3,300
EBIT (20%) 660
NOPAT (EBIT x .6) 396
Invest. operating working capital (30)
Net capital expenditures (330)
FCF 36

28
Problem 7

FCF FCFE
EBIT 600 600
x1–t .60 .60
= NOPAT 360 360
Increase in operating working capital (50) (50)
Net capital expenditures (500) (500)
FCF (190) (190)
Interest expense after tax (100 x .06) (60)
Increase debt (50% x 550) 275
FCFE 25

Problem 8

Sales (3,000 x 1.10) 3,300 3,300

Net income 198 (6% x 3,300)
Invest. operating working capital (30) 10% x (3,300 – 3,000)
Net capital expenditures (120) (40% x 3,300 – 3,000)
Debt increase 75  (150 x .5)
FCFE 123 

29
Problem 9

Panel A. Calculation of Discount Rate for Valuing Free Cash Flow

Ku = Rf + Bu (MRP)
= 4% + 0.8 (7%)
= 9.6%

Panel B. Calculation of Free Cash Flow Generated by the Business (FCF)

Year
   1       2       3       4       5   
EBIT 64 68 90 105 120
Tax 26 27 36 42 48
NOPAT 38 41 54 63 72
Depreciation 180 186 196 210 224
Capital expenditure (169) (189) (105) (129) (119)
Increase in operating w/c (32) (34) (45) (52) (60)
FCF 17 4 100 92 117
PV of FCF @ 9.6% 15 3 76 64 74

Panel C. Calculation of Terminal Value

TV = 117 x 1.03 = 1,826

.096 – .03

30
Problem 9 continued

Panel D. Cash Flows from Interest Tax Shields

Year
   1       2       3       4       5   
Interest expense 36 36 37 32 28
Interest tax shields x .4 14 14 15 13 11
PV of interest tax shields (disc at 6%) 13 12 13 10 8

Panel E. Calculation of Terminal Value for Interest Tax Shields

TVITS = 11. X 1.03 = 378

.06 – .03

Panel F. Total Enterprise Value

PV Free cash flows generated by the business

Years 1-5 $ 232
PV of TV 1,826/(1.096)5 1,155
Total Unleveraged Value 1,387
PV Cash flows from interest tax shields
Year 1-5 56
PV of TV (378/(1.06)5 282
Enterprise Value $1,725 

31
Problem 10

Panel A. Calculation of FCF

Year
   0       1       2       3   
Revenues 10,000 12,000 13,200
EBIT 1,000 1,800 2,640
IC end of year 6,000 6,600 6,930(1)
IC beginning of year 5,000 6,000 6,600
Calculation of FCF
EBIT 1,000 1,800 2,640
Tax on EBIT 400 720 1,056
NOPAT 600 1,080 1,584
Increase in IC 1,000 600 330
Free Cash Flow (Unlevered) (400) 480 1,254
PV @ 11% (360) 390 917
(1)
Sales year 4 of 13,200 x 1.05 = 13,860 x .50 = 6,930

Panel B. Calculation of TV Unlevered

TV = 1,254 x 1.05 = 21,945

.11 – .05

PV @ 11% = 16,046

Panel C. Calculation of Interest Tax Shields

Year    0       1       2       3   

Interest expense 300 240 200

Interest tax shields 120 96 80

PV (Discount rate 8%) 111 82 64

Problem 10 continued

32
Panel D. Calculation of TV for Interest Tax Shields

TV = 80 x 1.05 = 2,800 PV @ 8% = 2,223

.08 – .05

Panel E. Calculation of Equity Value

PV of FCF years 1 – 3 at 11% 947

PV of Unlevered TV at 11% 16,046
Total Unlevered Value 16,993
PV of Interest tax shields years 1 – 3 257
PV of TV for Interest Tax Shields 2,223
Enterprise value 19,473
Value financial assets --
Value of debt   3,000
Equity Value 16,473 

33
PRACTICE SET #3 – COMPARABLE
COMPANIES

PROBLEMS & SOLUTIONS

 PRACTICE SET #3 – COMPARABLE COMPANIES
PROBLEMS

Problem 1

From the information provided below for Top Service Cable Co., calculate the
EV/EBITDA multiple:

Price per share (current) $40.00

Diluted shares outstanding 600
Debt (most recent) $9,000
Preferred stock $100
EBITDA $1,800

Problem 2

ABC Company is privately held. It is planning an IPO. You have been asked to value
ABC Company using data from DEF Company, a close comparable to ABC. (In
practice, you would use more than one comparable).

(Dollar figures in millions)

ABC DEF
Sales $400 $600
EBITDA 25 40
EBIT 20 34
Net income 8 12
Book value of equity 60 100
Net debt 40 60
Share price Not available $20
Number shares outstanding 10 million 12 million

a. Compute price-to-earnings ratio for DEF.

b. Compute price-to-book value per share for DEF

c. Compute Enterprise value-to-EBITDA multiple for DEF.

d. Compute Enterprise value-to-EBIT multiple for DEF.

e. Compute Enterprise value-to-sales multiple for DEF.

f. Based on the above, provide 5 estimates of ABC’s value per share.

36
Problem 3

Newco is planning an IPO. Its EPS is 1.25 and book value per share is $15. The only
comparable that can be identified has a total equity market value of $50 million, total net
income of $2.5 million and book value of $25 million. What per-share IPO price does
the comparable imply?

Multiple Newco’s Newco’s

For Comparable x Number = Valuation

EPS x =

Book value x =

Ave. of valuations

Problem 4

This problem relates to valuing Smith Corporation, a private company. There are 6 parts
(Parts A – F) to this problem.

Part A
Shown below is data gathered on 5 publicly traded companies that have been selected as
comparables to Smith Corporation. Complete the schedule showing the equity and
enterprise value for each comparable.

Stock Price Number

Name of Per Share of Equity Enterprise
Comparable Shares    Debt   Value Value   
A 30 4,500 11,000

B 20 4,000 80,000

C 30 100 0

D 10 1,000 0

E 70 200 2,000

37
Problem 4 continued

Part B
Shown below is the last 12 months and forecasted EPS for each of the 5 comparables,
together with the current stock price. Complete the schedule showing the P/E multiples
(based on LTM and forecasted EPS) and the mean and median multiples.

Forecasted P/E based P/E based

Name of Stock Price LTM EPS on LTM on Proj
Comparable Per Share  EPS  (Next year) EPS EPS
A 30 1.03 1.36
B 20 1.25 1.82
C 30 Loss Loss
D 10 .71 .83
E 70 Loss Loss
Mean
Median
Range

Part C
Shown below is the last 12 months EBITDA and sales for each of the 5 comparables.
Complete the schedule showing the Enterprise value, EBITDA and sales multiples and
the mean and median multiples.

Name of Enterprise LTM LTM EV/LTM EV/LTM

Comparable    Value     EBITDA  Sales   EBITDA Sales   
A 12,170 121,700
B 21,600 320,000
C 400 12,000
D 1,300 9,900
E 2,000 20,000
Mean
Median
Range

38
 Problem 4 continued
Part D
Shown below is a schedule designed to show the indicated equity value of Smith
Corporation from application of the P/E multiples. Complete the schedule.

In Millions
Multiple
Multiple Selected as Smith Corp. Indicated
Selected Multiple Selected % of Median Fundamental Equity Value
P/E Based on LTM 100% $2,030
P/E Based on forecasted 100% $3,300
EPS (next year)
Part E
Shown below is a schedule designed to show the indicated equity value of Smith
Corporate from application of the EBITDA and sales multiples. Complete the schedule.
Valuation Smith Corp.
Multiple
Selected Multiple Multiple Selected as Smith Corp. Indicated Indicated
Selected % of Median Fundamental       EV      Debt Equity Value 
EV/LTM EBITDA 100% $ 4,935 $10,000
EV/LTM Sales 100% $50,000 $10,000

Part F
Shown below is a schedule designed to obtain an estimated equity value of Smith Corp.
based on application of the above market multiples. Complete the schedule.
Adjusted
Indicated Marketability    Discount   Equity   Value   Method Weighted
Selected Multiple Equity Weight Value
Value
P/E based on LTM 40% 25% $
EPS
P/E based on next 40% 25%
year’s EPS
EV/LTM EBITDA 40% 25%
EV/LTM Sales 40% 25%
Total Value $______
/ Shares outstanding 200
= Indicated equity value/share $

39
 Problem 5

Shown below is selected data for 4 comparables to the company you are valuing
(amounts in millions).

Revenue          EBITDA               Net Income     

Value Value Net
Firms Equity Debt LTM Next Year LTM Next   Year LTM Next Year
A 450 300 900 925 95 125 18 22

B 700 400 1,000 1,200 80 100 28 35

C 900 800 2,000 2,400 200 250 38 36

D 800 200 1,200 1,300 90 95 40 46

Complete the following schedule for the 4 comparables:

Trailing multiples Forward multiples

Revenue EBITDA P/E Revenue EBITDA P/E
A
B
C
D

Problem 6

Shown below are stock prices, Enterprise value, and EPS and EBITDA data for selected
retail stocks. Compute forward looking P/E and LTM EBITDA multiples.

EPS
Enterprise LTM
Firm Stock Price Value ($ millions) LTM Next Year EBITDA ($ million)
A 30.00 75 2.00 2.10 9.0
B 50.00 40 3.00 3.25 5.0
C 35.00 11 1.50 1.60 1.2

40
Problem 7

Shown below is an income statement for Struggler, Inc. for 2008:

Sales $12,000
Cost of sales 4,000
Selling, general, admin. Exp. 2,000
Goodwill writedown 3,000
Interest expense 1,000
Taxes 800
Net income 1,200
Shares outstanding 600

Your analysis of comparables is that the one chain P/E multiple based on 2008 earnings
per share is 14. Value Struggler’s stock price.

41
 PRACTICE SET #3 – COMPARABLE COMPANIES
SOLUTIONS

Problem 1

Price per share x shares = 600 x 40 = 24,000

Debt 9,000
Preferred stock 100
EV 33,100
EBITDA 1,800
EV/EBITDA 18.4x

Problem 2

a. Compute price-to-earnings ratio for DEF.

P/E ratio = 20/1 = 20 times

Where EPS = $12 million/12 million shares = $1.00 per share

b. Compute price-to-book value per share for DEF

Price/book value = 20/8.33 = 2.4 times

Where book value/share = 100/12 = 8.33

c. Compute Enterprise value-to-EBITDA multiple for DEF.

EV/EBITDA = 300/40 = 7.5 times

Where Enterprise Value =

Millions
Value equity = $20 x 12 million shares = $240
+ Value debt 60
= Enterprise Value $300

d. Compute Enterprise value-to-EBIT multiple for DEF.

EV/EBIT = 300/34 = 8.8 times

e. Compute Enterprise value-to-sales multiple for DEF.

EV/Sales = 300/600 = 0.5 times

42
Problem 2 continued

f. Based on the above, provide 5 estimates of ABC’s value per share.

Price-to-earnings = $.80 x 20 = $16.00

Where EPS of ABC = 8 million/10 million shares

Price-to-book value = $6 x 2.4 = $14.40

Where book value/share of ABC = $60 million/10 million shares

Enterprise Value-to-EBITDA:

$25 million x 7.5 = $187.50

Less debt 40.00
Equity value $147.50
Per share value = $147.50/10 = $14.75

Enterprise Value-to-EBIT:

$20 million x 8.8 = $176.00

Less debt 40.00
Equity value $136.00
Per share value = $136/10 = $13.60

Enterprise Value-to-sales:

$400 million x .5 = $200

Less debt 40
Equity value $160
Per share value = $160/10 = $16.00

Range of values: $13.60 - $16.00

43
Problem 3

Multiple Newco’s Newco’s

For Comparable x Number = Valuation

EPS 20 x 1.25 = 25

Book value 2 x 15 = 30

Ave. of valuations 27.50

Comparable EPS multiple = 50MM/2.5 = 20x

Comparable BV multiple = 50MM/25MM = 2x

Problem 4

Part A
Number
Name of Stock Price of Equity Enterprise
Comparable Per Share Shares    Debt   Value Value   
A 30 4,500 11,000 135,000 146,000
B 20 4,000 80,000 80,000 160,000
C 30 100 0 3,000 3,000
D 10 1,000 0 10,000 10,000
E 70 200 2,000 14,000 16,000

Part B
Forecasted P/E based P/E based
Name of Stock Price LTM EPS on LTM on Proj
Comparable Per Share  EPS  (Next year) EPS EPS
A 30 1.03 1.36 29.1 22.1
B 20 1.25 1.82 16.0 11.0
C 30 Loss Loss --- ---
D 10 .71 .83 14.1 12.0
E 70 Loss Loss
Mean 19.7 15.0
Median 16.0 12.0
Range 14.1-29.1 11.0-22.1

Selected median since Smith Corp. performance ratios vs. comparables not shown.

44
 Problem 4 continued

Part C

Name of Enterprise LTM LTM EV/LTM EV/LTM

Comparable    Value     EBITDA  Sales   EBITDA Sales   
A 146,000 12,170 121,700 12.0 1.20
B 160,000 21,600 320,000 7.4 0.50
C 3,000 400 12,000 7.50 0.25
D 10,000 1,300 9,900 7.69 1.01
E 16,000 2,000 20,000 8.0 0.80
Mean 8.52 0.75
Median 7.69 0.80
Range 7.4-12.0 0.25-1.20

Part D
In Millions
Multiple
Multiple Selected as Smith Corp. Indicated
Selected Multiple Selected % of Median Fundamental Equity Value
P/E Based on LTM 16.0 100% $2,030 32,480
P/E Based on forecasted 12.0 100% $3,300 39,600
EPS (next year)

Part E
Valuation Smith Corp.
Multiple
Selected Multiple Multiple Selected as Smith Corp. Indicated Indicated
Selected % of Median Fundamental       EV      Debt Equity Value 
EV/LTM EBITDA 7.69 100% $ 4,935 37,950 $10,000 27,950
EV/LTM Sales 0.80 100% $50,000 40,000 $10,000 30,000

45
 Problems 4 continued

Part F
Adjusted
Indicated Marketability    Discount   Equity   Value   Method Weighted
Selected Multiple Equity Weight Value
Value
P/E based on LTM 32,480 40% 19,488 25% $4,872
EPS
P/E based on next 39,600 40% 23,760 25% $5,940
year’s EPS
EV/LTM EBITDA 27,950 40% 16,770 25% $4,193
EV/LTM Sales 30,000 40% 18,000 25% $4,500

Total Value $19,505

/ Shares outstanding 200

= Indicated equity value/share $ 97.53

Problem 5

Trailing multiples Forward multiples

Revenue EBITDA P/E Revenue EBITDA P/E
A 0.83 7.9 25.0 0.81 6.0 20.4

B 1.1 13.8 25.0 0.92 11.0 20.0

C 0.85 8.5 23.7 0.71 6.8 25.0

D 0.83 11.1 20.0 0.77 10.5 17.4

46
Problem 6

EPS
Enterprise LTM
Firm Stock Price Value ($ millions) LTM Next Year EBITDA ($ million)
A 30.00 75 2.00 2.10 9.0
B 50.00 40 3.00 3.25 5.0
C 35.00 11 1.50 1.60 1.2

A 30/2.10 = 14.3 P/E 75/9 = 8.3 x EBITDA

B 50/3.25 = 15.4 P/E 40/5 = 8.0 x EBITDA
C 35/1.60 = 21.9 P/E 11/1.2 = 9.2 x EBITDA

Problem 7

EPS as reported = 1,200/600 = 2.00

Recurring EPS = 3,000/600 = 5.00
Stock price = 5.00 x 14 = $70
Recurring EPS:
Pretax income w/o goodwill 5,000
Tax (40%) 2,000
Net income 3,000
Shares 600
Per share $5.00

47
PRACTICE SET #4 – MERGERS AND
ACQUISITIONS

PROBLEMS & SOLUTIONS

 PRACTICE SET #4 – MERGERS AND ACQUISITIONS
PROBLEMS

Note: Unless otherwise indicated, assume that the pre-announcement stock price=
intrinsic value of the stock.

Problem 1

B has offered $42 per share cash for each share of T’s stock. Data on B and T are shown
below:

    B         T    
Pre-announcement stock price per share $ 84 $ 30
Shares outstanding (millions) 20 10
Equity value $1,680 $ 300

The present value of the synergies is $100 million.

(A) What is the total amount in millions offered for T?

(B) What premium (in millions) was offered to T?

(C) What is buyer’s gain (loss) in millions?

(D) Now consider that B has offered 0.5 share of B for each share of T. Calculate the
per share value of the merged firm.

(E) Based on your answer in (D) above, what is the actual premium paid to target’s
shareholders?

(F) Based on your answer in (D) above, what is the buyer’s gain (loss)?

49
 Problem 2

Shown below is pre-announcement data for B and T (B = buyer; T = target).

    B         T    
Pre-announcement stock price $ 50 $ 40
Shares outstanding (millions) 24 8
Market value (millions) $1,200 $ 320

B offers $20 cash plus 0.6 shares of B per share of T. Synergies are estimated at $100
million.

(A) What is T’s gain?

(B) What is B’s gain (loss)?
(C) What are the break-even synergies?

Problem 3

Shown below are the assumptions for an acquisition candidate.

Actual Forecast
2008 2009 2010 2011 2012 2013
Sales 100
Net PP&E (end year) 40
Oper. Working Capital (end year) 20

Sales growth 8% 7% 6% 6% 5%
EBIT margin 10% 10% 10% 9% 9%
Tax rate 40% 40% 40% 40% 40%
Net PP&E (end year)/Sales 40% 40% 40% 40% 40%
Oper. Working Capital (end year)/Sales 20% 20% 20% 20% 20%

In addition:

 After year 5 sales growth is 5% per year; EBIT margin is 9%, tax rate is 40%, and
asset/sales ratios remain the same
 WACC = 8%
 Debt and nonoperating assets = $0

Estimate maximum amount to be paid. Use template below.

50
Problem 3 continued

End Year IC

 2009   2010   2011   2012   2013 

Sales
End Year Net PP&E
End Year Oper. Working Capital ____ ____ ____ ____ ____
End Year IC
Incr. in IC

FCF Calculation

 2009   2010   2011   2012   2013 

Sales
EBIT
Tax ____ ____ ____ ____ ____
NOPAT
Increase in IC ____ ____ ____ ____ ____
FCF
PV of FCF

51
Problem 3 continued

TV Calculation
FCF
2014
Sales
NOPAT
Incr. IC _____ TV =   FCFyr. 2014 
(WACC – g)
FCF _____

IC = $           

End 2014
End 2013 _____
Increase _____

Calculation of Maximum Amount to Pay

PV of FCF 2009 – 2013
PV of TV _____
Enterprise value
+ Nonoperating assets
– Value debt _____
Equity Value _____

ROIC Calculation*
 2009   2010   2011   2012   2013   2014

NOPAT
IC (beg. year)
ROIC
*Use beginning of year IC for simplicity

52
Problem 4

You are evaluating Tasty Turnips, an acquisition candidate. You have selected recent
acquisitions of comparable companies as set forth below:

Total LTM LTM

Date Enterprise Sales EBITDA
Announced     Value     (millions) (millions)
A acquired B 4/3/08 270 380 30
C acquired D 5/1/07 600 700 75
E acquired F 10/2/06 350 400 40

Latest Income Statement for Tasty Turnips:

Sales 273
Cost of sales 123
Gross Profit 150
Operating exp. before depr . 120
EBITDA 30
Depreciation 5
Interest expense 6
Taxes 7
Net Income 12

Using acquisition multiples, what is the value of Tasty Turnips? Apply median
multiples for comparables.

53
 PRACTICE SET #4 – MERGERS AND ACQUISITIONS
SOLUTIONS

Problem 1

(A) $42 x 10 = $420 million

(B) $42 - $30 = $12 x 10 = $120 million

(C) Premium $120 million

Synergies 100 million
Loss to B $ 20 million

Note: Synergies of $100 split $120 to T, $20 loss to B.

(D) Post acquisition equity value = 1,680 + 300 + 100 = 2,080

Post acquisition shares:
Shares issued = 0.5 x 10 = 5
Pre existing shares 20
25

Per share value merged firm = 2,080/25 = 83.20

(E) T receives 5 million shares @ 83.20 = 416 million

Pre acquisition value 300
True premium 116

(F) Pre acquisition price 84.00

Post acquisition price 83.20
Loss per share ( .80)
x Shares pre acquisition 20 million
= Loss to B (16) million

Alternate computation:
Pre-acquisition value of buyer 300 million
Synergies 100
Cost of stock(83.20x5shares) (416)
Loss to B (16) million

54
Problem 2

(A) T’s gain = premium = price paid less pre-acquisition price.

(i) Cash payment = 20 x 8 = 160

(ii) Post acquisition equity value = 1200 + 320 + 100 – 160 = 1,460
(iii) Post acquisition shares = 24 + 0.6(8) = 28.8
(iv) Post acquisition share price = 1,460/28.8 = 50.69
(v) Price paid to T = post acquisition share price x new shares issued + cash =
50.69 x (0.6 x 8) + 160 = 403.31
(vi) T’s gain = 403.31 – 320 = 83.31

(B) B’s gain = synergies – T’s gain = 100.0 – 83.31 = 16.69

Alternate computation:
T’s preacquisition value 320.00
synergies 100.00
shares given x post acquisition share price ( 0.6x 8)(50.69) ( 243.31)
cash (160.00)
B’s gain 16.69

(C) Breakeven synergies = shares issued to T x pre-acquisition share price of B + cash

– pre-acquisition equity value of T = (4.8 x 50) + 160 – 320 = 80

Proof
Post acquisition equity value = 1200 + 320 + 80 – 160 = 1,440
Post acquisition shares = 28.8
Post acquisition share price = 1440/28.8 = 50 (which equals pre
acquisition share price of B).

55
Problem 3

End Year IC

 2009   2010   2011   2012   2013 

2008
Sales 108 115.6 122.5 129.8 136.3
End Year Net PP&E 43.2 46.2 49.0 51.9 54.5
End Year Oper. Working Capital 21.6 23.1 24.5 26.0 27.3
End Year IC 60 64.8 69.3 73.5 77.9 81.8
Incr. in IC 4.8 4.5 4.2 4.4 3.9

FCF Calculation

 2009   2010   2011   2012   2013 

Sales 108 115.6 122.5 129.8 136.3

EBIT 10.8 11.6 12.3 11.7 12.3
Tax 4.3 4.6 4.9 4.7 4.9
NOPAT 6.5 7.0 7.4 7.0 7.4
Increase in IC 4.8 4.5 4.2 4.4 3.9
FCF 1.7 2.5 3.2 2.6 3.5

PV of FCF 1.6 2.1 2.5 1.9 2.4

56
Problem 3 continued

TV Calculation
FCF
2014
Sales 136.3 x 1.05 143.1
NOPAT (9% x 60% x 143.1) 7.7
TV =   FCFyr. 2014 
Incr. IC 4.1
(WACC – g)
FCF 3.6 = 3.6/(.08 - .05)

= $ 120 
IC
End 2014 (60% x 85.9
143.1)
End 2013 81.8
Increase   4.1

Calculation of Maximum Amount to Pay

PV of FCF 2009 – 2013 10.5
PV of TV 81.7
Enterprise value 92.2
+ Nonoperating assets 0
– Value debt _0_
Equity Value 92.2

ROIC Calculation
 2009   2010   2011   2012   2013   2014

NOPAT 6.5 7.0 7.4 7.0 7.4 7.7

IC (beg. year) 60.0 64.8 69.3 73.5 77.9 81.8
ROIC 10.8% 10.8% 10.7% 9.5% 9.5% 9.4%

57
Problem 4

EV/Sales Multiple EV/EBITDA Multiple

A/B .710 9.00

C/D .857 8.00

E/F .875 8.75
Median .857 8.75

Implied Value Tasty Turnips

Based on Based on
Sales Multiple EBITDA Multiple

.857 x 273 234.0

8.75 x 30 262.50

58
PRACTICE SET #5 - RESTRUCTURING

PROBLEMS & SOLUTIONS

 PRACTICE SET #5 - RESTRUCTURING
PROBLEMS
Problem 1.

Diversified, Inc. has three divisions that are unrelated to each other. Show below
is the net income of each division, and the P/E multiple that you think it should be valued
at based on your comparable company analysis.

Division Net Income P/E Multiple

A $2,000 8x
B $1,000 9x
C $400 20x

Unallocated overhead absorbed by the parent organization is $300. There are

1,000 shares outstanding. Consolidated EPS after overhead is $3.10.

The stock of the parent sells for $26. Shares outstanding total 1,000. This
represents a consolidated P/E multiple of 8.4x. (Consolidated net income from 3
divisions is $3,400 and after overhead of $300, Consolidated net income is $3,100 or
$3.10 per share. $26.00 stock price/$3.10 = 8.4x.) You conclude that subsidiary C is not
getting its proper value in the market place. You have come up with 3 alternatives:

Alternative 1: Do an IPO of subsidiary C. You would sell 20% of the stock to the public
on a tax free basis. Your investment banker agrees with your valuation of 20 P/E
multiple but advises you that your net proceeds will be 80% of the subsidiary’s trading
value due to IPO discount and fees.

Alternative 2: Do a spinoff of subsidiary C on a tax-free basis.

Alternative 3: Sell subsidiary C to a third party strategic buyer. Your banker believes it
can get a third party to acquire the unit at a P/E multiple of 25x. Your tax staff tells you
the tax basis for purposes of sale is $2,000. Tax rate is 40%.

Question 1: What is the estimated conglomerate discount?

Question 2: What is the potential increase in value for each alternative and impact on
firm’s cash position?

59
 Solution Question 1

Division Net Income P/E Multiple Equity Value

A $2,000 8x $16,000
B $1,000 9x 9,000
C $ 400 20x 8,000
Total $33,000
Overhead ($300X 8.4 current ( 2,520)
p/e)
Value equity $30,480
Shares 1,000
Per share $ 30.48
Trading value $ 26.00
Discount -$ $ 4.48
-% 15%

Solution Question 2

Alternative 1: IPO

Post IPO

Division Net Income P/E Multiple Equity Value

A $2,000 8 $16,000
B $1,000 9 9,000
C $ 320 (80%) 20 6,400
cash 1,280*
Total $32,680
Overhead (assume no change) ( 2,520)
Combined equity value $30,160
Shares 1,000
Value per share $ 30.16
Current price per share $ 26.00
Gain -$ $ 4.16
-% 16%

Comment: Assumes 80% of subsidiary C that is retained will be re-priced at the

value the 20% is trading in the market.

The cash proceeds are:

Value Subsidiary C 400 x$ 20 = $8,000

Sell 20% 1,600
Proceeds (80% x 1,600) $1,280

60
Alternative 2

Post Spinoff

Diversified Inc.

Division Net Income P/E Multiple Equity Value

A $2,000 8x $16,000
B $1,000 9x 9,000
25,000
Overhead (assumes no change) (2,520)
Total $22,480
Value received by shareholders – subsidiary C 8,000
Total value of 2 firms-Diversified Inc. + $30,480*
subsidiary C
Shares outstanding 1,000
Combined value – shares in Diversified Inc.
+ Subsidiary C 30.48
Current price per share 26.00
Gain -$ $4.48
-% 17%

No cash gain

*Value $320 higher than IPO since IPO cost is 20% of $1,600 proceeds.

61
Alternative 3 – Sale to Third Party

After Sale

Division Net Income P/E Multiple Equity Value

A $2,000 8x $16,000
B $1,000 9x 9,000
(1)
Cash from sale 6,800
Total $31,800
Overhead (assumes no change) (2,520)
Combined value $ 29,280
Shares 1,000
Value per share $ 29.28
Current price per share $ 26.00
Gain -$ $3.28
-% 13%
(1)
Cash from sale

Proceeds on sale ($400 x 25) $10,000

Tax basis 2,000
Tax gain $ 8,000
Tax – 40% 3,200

Proceeds from sale $10,000

Pay tax 3,200
Cash to buyer 6,800

62
PRACTICE SET #6 - LBOs

PROBLEMS & SOLUTIONS

 PRACTICE SET #6
PROBLEMS

Problem 1

A. An LBO candidate currently has EBITDA of $150 and net debt of $50. The
financial buyer can borrow up to 6x total EBITDA (including refinancing current
net debt of $50). What is the maximum amount of debt that financial buyer can
borrow?
B. Assume the financial buyer is willing to contribute 25% of the total purchase
price as equity. What is the dollar amount of equity contribution?
C. A 5 year projection shows that EBITDA of $150 will be increased to $170 in year
5. Total debt will be reduced to $350. Assuming no multiple expansion, what is
enterprise value end of year 5?
D. What is equity value end of year 5?
E. How much did equity value increase over 5 years and why?
F. Assume the financial buyer requires 25% IRR. What is the maximum equity that
can be invested in LBO?
G. Is this LBO deal feasible? What does it depend upon?

63
 PRACTICE SET #6
SOLUTIONS

A. EBITDA 150

Multiple x 6
Total debt permitted 900

B. Total debt 900 75%

Equity 300 25%

Purchase price 1,200 100%

Maximum purchase price = total debt capacity/(1 - % equity contribution)

= 900/.75 = 1,200

C. Purchase price 1,200

/EBITDA 150

=Purchase multiple 8

Enterprise value (sales price) year 5 = 170 x 8 = 1,360

D. Enterprise value year 5 1,360

Debt year 5 350

Equity value year 5 1,010

E. Equity value year 5 1,010

Equity value at purchase 300

Increase equity value 710

Increase due to operating improvements and debt paydown.

F. 1,010/(1.25)5 = 331

G. Seller accepting price of $1,200

64
 Practice Set #7 – Valuation of Private Firms

Problem #1

You are valuing a restaurant that is being offered for sale by its well-known chef-owner.
Last year the restaurant had FCF of $1 million. Expected growth rate is 2%, and WACC
is 12%. Restaurant debt is $100,000.

You acquire the restaurant. You expect FCF to drop 20% per year if the chef leaves.

Question A – what is the value of the restaurant assuming the chef remains?

Question B – what is the value of the restaurant if the chef departs but signs a non-
compete agreement?

Question C – Assume that you are going to acquire the restaurant, the chef departs, but
you secure a non-compete agreement at an after tax cost of $50,000. You negotiated a
discount for lack of liquidity of 25%. What price would you pay?

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 Solutions to Practice Set #7 – Valuation of Private Firms

Problem #1

Question A – Value of restaurant = $1,000,000 (1.02)

.12 - .02

= $10,200,000

Question B – Value of restaurant = $ 800,000 (1.02)

.12 - .02

= $8,160,000

Question C – Purchase price

Value of restaurant
without chef = $8,160,000
Less: non compete
agreement 50,000

Less: debt 100,000

Value equity 8,010,000
Discount lack of
marketability 2,002,500
Price to pay $6,007,500

Assumes after non-compete expires, chef doesn’t compete.

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