Seminar 7 N1591

Valuation of Companies and Cash Flow Generating Assets (N1591)

Autumn Term 2019/20

Seminar 7: Moving from Enterprise Value to Value per Share (McK Chap 14) and
Leases and Retirement Obligations (McK Chap 20)

Review of Reading Week Assignment.

All relevant materials are in the Reading Week section on Canvas.

Calculation Questions

1. You are valuing a company that has $ 200m in debt using probability‐weighted scenario
analysis. You carefully model three scenarios, such that the resulting enterprise value equals
$ 300m in Scenario 1, $ 200m in Scenario 2, and $ 100m in Scenario 3. The probability of
each scenario is 25%, 50%, and 25% respectively.

What is the expected enterprise value? What is the expected equity value?

Management announces a new plan that eliminates the downside Scenario 3, making
Scenario 2 that much more likely. What happens to enterprise value and equity value? Why
does enterprise value rise more than equity value?

2. You are valuing a technology company whose enterprise value is $ 800m. The company
has no debt, but considerable employee options, 10m in total.

Based on option-pricing models, you value each option at $ 6.67. Assume that the stock trades
at $ 18.33/share and that the average exercise price equals $ 15. If the company has 40m
shares outstanding, what is the company’s equity value and value per share using (a) the
option pricing models and (b) exercise value approach? Why is the option pricing model the
preferred method?

3. MarineCo manufactures, markets, and distributes recreational motor boats. Using

discounted free cash flow, you value the company's operations at $ 2,500m. The company has
a 20% stake in a non-consolidated subsidiary. The subsidiary is valued at $ 500m. The
investment is recorded on MarineCo's balance sheet as an equity investment of $ 50m. The
company's marginal tax rate is 30%.

Based on this information, what is MarineCo's enterprise value? If new management

announced its plan to sell the company's stake in the subsidiary at its current value, how would
that change your valuation?

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4. MarineCo has unfunded pension liabilities valued at $ 200m, recorded as a long‐term other
liability. MarineCo has detailed a potential legal judgment of $ 100m for defective engines in
its annual report. Since management estimates a 90% likelihood the judgment will be enforced
against the engine maker and not MarineCo, they have not reported a liability on the balance
sheet. The company’s marginal tax rate is 30%.

Based on this information and information provided in Question 3 (assuming no sale of the
subsidiary), what is MarineCo’s equity value?

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Multiple Choice Questions

5. Which of the following are true concerning non-operating assets that can be converted into
cash on short notice and at low cost?

I. They are classified as excess cash and marketable securities.

II. Short-term losses can be deducted directly from their value, bypassing the income
statement.
III. Under International Financial Reporting Standards (IFRS), they are to be reported
at fair market value on the balance sheet.
IV. Under US Generally Accepted Accounting Principles (GAAP), they are to be
reported at fair market value on the balance sheet.

A. I and IV only.
B. I, II, and III only.
C. I, III, and IV only.
D. III and IV only.

6. When accounting for operating leases, the rental expense is split into:

A. Interest expense and capex.

B. Interest expense and depreciation.
C. Depreciation and acquisition cost.
D. Depreciation and capital gain.

7. Prior to the implementation of IFRS 16, if operating leases were not accounted for:

A. Revenue/Invested Capital was distorted downward and operating margin upward.

B. Revenue/Invested Capital was distorted downward and operating margin downward.
C. Revenue/Invested Capital was distorted upward and operating margin downward.
D. Revenue/Invested Capital was distorted upward and operating margin upward.

8. What is a debt like obligation?

A. Any liability of a company requiring an interest payment.

B. Any financial liability a company may have.
C. Any liability a company is legally obliged to meet, and whose servicing is necessary for its
continuing operations.
D. All on-balance sheet liabilities of a company not explicitly accounted for as debt.

9. Company X controls Company Y so that Company Y’s financial statements are fully
consolidated into the group accounts. With respect to Company X’s financial statements, third
party stakes in Company Y:

A. Are not of concern.

B. Are to be deducted from Enterprise Value and called minorities.
C. Are to be added to Enterprise Value and called minorities.
D. Are illegal.

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10. What is a contingent liability?

A. A certain liability that will occur, not dependent on the outcome of an uncertain future event.
B. A potential liability that may occur, depending on the outcome of an uncertain future event.
C. A potential liability that may occur, not dependent on the outcome of an uncertain future
event.
D. A potential liability that will occur, depending on the outcome of an uncertain future event.