Problem 1

Expected Operating income in year 5 = 10.0567859 ! $ 5 million growing at 15% for 5 years
Current estimate of terminal value = 150.851789 ! 15 times operating income

Expected Operating income in year 6 = 10.3584895

Reinvestment rate in year 6 = 0.3 ! Reinvestment rate = g/ ROC
Expected FCFF in year 6 = 7.25094266
Estimated terminal value in year 5 = 103.584895 ! FCFF in year 6/ (Cost of capital -g)

Difference in terminal values = -47.2668939

PV of difference in terminal value = -29.3490223

Correct value of the firm = 120.650978 ! Estimated value minus PV of difference in terminal valu

Problem 2
Aftertax Operating Margin for PEMEX = 3.50% ! 300 (1-.3)/6000

a.
Expected EV/Sales Ratio for PEMEX = 0.8
Expected EV for PEMEX = $4,800.00
Debt outstanding= $1,500.00
Value of equity = $3,300.00
Value per share = $33.00

b.
Market's estimate of equity value = 4500
Plus Debt Outstanding = 1500
Estimated EV for PEMEX = 6000
Market's estimate of EV/Sales ratio - 1
Market's estimate of after-tax margin = 4.16666667
Aftter-tax operating income = 250
Pre-tax operating income = 357.142857
Current operating income = 300
Estimated cost savings next year 57.1428571

Problem 3
Return on Equity for Boeing = 8.00% ! Net income next year/ BV of equity
Equity Reinvestment rate = 37.50% ! G/ ROE
Estimated continuing value = 357.142857 ! 40*(1-.375)/(.10-.03)
Estimated divestiture value = 300
Effect of diverstiture on Boeing = -57.1428571 ! Value will drop

After-tax ROC = 0.1 ! Expected growth rate/ RIR =.04/.4

Expected growth rate after restructuring 0.04

Value of firm before change = $13,600.00 ! 1000 (1.02) (1-.2)/(.08-.02)

Value of firm after change = $15,600.00 ! 1000 (1.04) (1-.4)/(.08-.04)
Change in value as a result of change = $2,000.00
Problem 4
Status quo value
Expected return on capital = 0.08
Expected reinvestment rate= 0.25
Value of firm = 174.857143

Optimal value (if you keep growth fixed and reduce reinvestment rate) Optimal value (if you keep re
Expected return on capital = 12% New growth rate =
Expected reinvestment rate = 0.16666667 New value =
Operating income = 226.666667

Value of control = $51.81

b. PV of cost savings in perpetuity = $637.50 ! Since the timing was a little

Effect of 3 year delay = $478.96 on different timing assumpti

Problem 5
If $ 10 million goes to buy out an existing equity investor If $ 10 million is fresh capita
Reinvestment rate = 0.2 Value of firm =
Pre-money Value of firm = 40 + Venture capitalist contribu
Venture capitalist's contribution = 10 Post-money valuation=
Percentage share of firm = 25.00% Percentage share of firm =

b. Option to buy an additional 25%

Pre-money Post Money
Value of 25% of the firm = 10 12.5
Exercise price = 12 12 d1 = 0.4626
Life of the option = 5 5 d2 = -0.4319
Standard deviation in firm value = 0.4 0.4
Riskless rate = 4% 4%
Value of option = $3.50 $5.28

c. Option to abandon
Initial investment = 10
Strike price = 5 d1 = 1.4414
Life of the option = 5 d2 = 0.5469
Standard deviation in firm value = 0.4
Riskless rate = 4%
Value of put option = $0.45
There should be no effect of pre or post money calculations here since it is based upon the money actually inve
 With the information given in this problem, there is no way that
you can estimate the cashflows each year for the next 5 years. But, you don't have
since you agree with the estimates made by the analyst. The only point on which y
disagree is the terminal value. Hence, computing the change in the terminal value
switching (from multiple to a perpetual growth model) and bringing it back to today
give you the answer.

difference in terminal values

Most common error

Forgot to pre-tax the after-tax margin. Came up with a cost savings of 40 million

Some of you overlooked the fact that net income was already next year's number and applied a
This makes the value about $368 million. I was compassionate.
timal value (if you keep reinvestment fixed and increase growth)
w growth rate = 0.03 ! Current after-tax operating income doe
247.2 change because ROC improves only on n

$72.34

ince the timing was a little ambiguous, I gave credit for a wide range of answers based
different timing assumptions (starting in year 3, starting in year 4 etc….)

$ 10 million is fresh capital that comes into the firm for investments ! Full credit for both computations
lue of firm = 40
Venture capitalist contribution = 10
st-money valuation= 50
rcentage share of firm = 20.00%

N(d1)= 0.6782 ! Clearly the cost of delay bedevils some of you still. The way to think
N(d2) = 0.3329 is to ask yourself what the cost of waiting to exercise this option to b
of the firm would be. Unless, there is some reason to believe that the
less valuable on an annual basis, there is no cost of delay. If you use
which is what many of you did, you are essentially assuming that this
it's assets every year and return the cash to the owners.
It is true that there was a cost of delay in the abandonment option th
The difference is that the abandonment option in class was on a finite
N(d1)= 0.9253 here is on an ongoing firm.
N(d2) = 0.7078

on the money actually invested up front..

 ears. But, you don't have to
he only point on which you
ge in the terminal value from
d bringing it back to today should

s number and applied a (1+g) to it.

ax operating income does not
ROC improves only on new investments.

oth computations

you still. The way to think about it

exercise this option to buy an additional 25%
eason to believe that the firm will become
cost of delay. If you use a cost of delay of 20%
ntially assuming that this firm will liquidate 20% of
the owners.
e abandonment option that we looked at in class.
on in class was on a finite project, whereas the option