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Quiz 3 Sol
Quiz 3 Sol
Problem 1
VS = AT Operating Margin * (1- Reinvestment Rate) * (1 + g)/(WACC - g)
Reinvestment Rate = g / ROC = g / (AT Operating Margin * Sales/Capital)
Let the margin for Generic Office be x,
VS for Generic Office = 1.5 = x (1-.05/2x)(1.05)/(.10-.05)
Solve for x,
x = (1.5*.05+(.05/2)*1.05)/1.05
x= 9.64%
HK's after-tax operating margin = 9.64% (1.05) = 10.13% ! I also gave full credit if you added 5% to get 14.64%
HK's VS ratio =.1013 (1-.05/2*.1013)(1.05)/(.10-.05) = 1.6023
Problem 2
a. Value of Developed Reserves = 100,000 * (300-200) * (PV of Annuity, 5 years, 9%) =
b. Value of Undeveloped Reserves (on DCF basis)
Value of oil in the ground = 40,000 * (300-200) * (PV of Annuity, 9%, 12.5 years) =
Value of oil in the ground allowing for development lag = 29,309,311/1.08 =
Fixed cost of development =
DCF Value of Undeveloped reserves =
I also gave full credit for a number of variations, including
a. Assuming that costs and prices are in present value dollars, in which case the value of reserves is [500000*(300-200)]/1.08 = 46,296,296
c. Inputs for Option Pricing Model
y = Annual Production Revenue/Reserves = 40,000/500,000 = 8.00%
d. The developed reserves will become less valuable, since oil prices are down.
The undeveloped reserves may become more or less valuale depending upon whether the effect of S or the effect of variance is greater on the option value.
gave full credit if you added 5% to get 14.64%
! Note that if you do not adjust the reinvestment rate, you
get 1.575.
$ 38,896,513
6,296,296
Problem 2
Present Value of FCFF from developed reserves = 300 (PVA,10 years, 9.375%) $ 1,894
Cost of Capital = 12%(25/40) + 5% (15/40) = 9.38%
Value of undeveloped reserves = 4000 - 1894 = $ 2,106 ! Do not subtract from the value
Problem 3
d1 = -0.15 N(d1) = 0.4404
d2= -0.90 N(d2) = 0.1841
Problem 2
Net Income 2 ! Remember to subtract after-tax expense = 2.6 - 1(1-.4)
ROE 20.00%
Total Beta 2.75
PBV = 1.94
MV of Equity = 19.4
Problem 3
S= 106.698524
K= 131.698524
t= 12
Variance = 0.0225
Riskless rate = 5%
cost of delay= 0.08333333 ! I think you can also make a reasonable case for 1/8 if you arg
that competition would kick in after the 8th year.
! In fact, you can even make a reasonable case for it being 0. If
0 and want to justify it, give me your reason…
ax operating margin * Sales/BV of capital
rate = g/ ROC
= 2.6 - 1(1-.4)
Next clean up the debt for the consolidated debt from Silicon
Value of debt = 2000
- Value of Debt in Silicon Tech = 500 ! Silicon Tech's debt is consolidated in balanc
Value of debt in Steel business = 1500
Problem 2
a. Estimated PS in year 5 = 3.5 ! Net margin = 10%; 1.5 + .2 (10) = 3.5
Estimated Equity value in year 5 = 1750 ! 3.5 * 500
b. Total beta = 2.25
Cost of equity = 14.00%
c. Value of equity today (going concern) = $908.90 ! 1750/1.14^5
Survival adjusted equity value = $363.56 ! 908.90 * .40
debt is consolidated in balance sheet
c. There should be an illiquidity discount in the private transaction but not on the IPO.
Problem 2
Part a
Value of commercial product = $88.63
Value of R&D = $45.00
Total = $133.63
Part b
If the firm develops the patent today, you will replace the option value above with the NPV
NPV = $49.39
Change in value = -$56.98 ! 49.39 - 106.37
New firm value = $183.02 ! 240 - 56.98
Problem 1
a. Intrinsic price to book ratio = 0.83333333 ! (ROE - g)/ (COE -g); ROE =8%, Cost of equity = 5+4%
Stock is undervalued slightly.
b. if the market is correct
Price to book ratio = .8 = (.08-.03)/(r-.03)
Solving for r, Cost of equity = 9.25%
Problem 2
Levered beta = 1.56
EV/Sales based upon regression= 2.028 ! 0.30 + .08 (15/100) - 1.2 (1.56) + .12 (20)
Actual EV/Sales ratio = 2.5 ! (200 + 100 -50)/100
Stock is overvalued by 23.27% ! Divided the actual by the expected value
Problem 3
Total beta = 3! Sale in a private transaction. Divided beta by correlation.
Cost of equity = 17.00% ! 5% + 3*4%
Reinvestment rate = 0.4 ! G/ROC = 4%/10%
Status quo value of firm = $ 6.92 ! 1.5 (1-.4)/(.17-.04); I don't need a (1+g) because 1.5 is
Value of 25% stake in firm = $ 1.73
pected value ! You cannot compare the predicted value to the average for the sector. That tells you very little.
nce this is an IPO valuation, you have to revalue the company with a market beta.
or. That tells you very little.
Problem 1
Gloria Inc. Generic Brand Name Value
After-tax Operating Margin 0.15 0.075
Return on Capital 0.25 0.125
Reinvestment Rate 0.2 0.4
EV/Sales 2.4 0.9
Enterprise Value $ 2,400.00 $ 900.00 $ 1,500.00
Problem 2
Cost of equity = 10.0% ! Use market beta since this is for initial public offering
Part a. Under existing management
EBIT (1-t) $ 5.00
Return on capital = 0.1
Reinvestment Rate = 0.4 ! 4./10
Value of firm = $ 50.00 ! No surprise here. If you earn your cost of capital, MV = BV
Value per non-voting share = $10.00 ! Divide status quo value by total number of shares
Value per voting share = $12.50 ! Add Value of control/ Number of voting shares
for initial public offering
Problem 3
Corrected income = $300,000.00 ! Subtracted out rent (75,000), accounting
After-tax income= $180,000.00 Why subtract out the dentist salary? If you
practice for something that does not belong
Total beta = 2.4 ! 0.80*3 business. You could be a non-dentist, buy
Cost of equity = 13.85%
! On the total beta calculation, I did give fu
Value of practice = $1,549,367.09
r ways to get to the same solution. You could set up firm value
04/ROC)/ (.09-.04)
ly you do not need a (1+g) in the numerator since I have given you next year's operating income
edit to those who used it.
ta calculation, I did give full credit if you assumed that the R squared was 33% and took the square root of it.
square root of it.
Problem 1
a. Tax Rate: The higher the tax rate, the lower the EV/EBITDA multiple should be (not higher)
b.
EV/EBITDA = 2.26 + .1513 (Tax Rate) + .2156 (Return on Capital) – .1335 ! You cannot change the s
EV/EBITDA = 7.9059
Problem 2
Market value fo equity = 1800
Net Income next year = 1500
Problem 3
Total Beta = 1.2/.4 = 3 ! Market beta/ Square root of R squared
Cost of equity = 5% + 3*4% = 17.00%
Reinvestment rate = 0.25 ! G/ ROC
Value of firm = $66.21
Cost of equity to publicly traded firm = 0.098 ! Investors in publicly traded firm are diversi
new return on capital = 0.18 ! I also gave full credit if you adjusted the gr
New reinvestment rate = 0.16666667
Value of firm = $ 151.47 ! Only the growth rate or reinvestment rate w
Value of 51% = $ 77.25 Existing operating income remains unchange
not higher)
You cannot change the sign on a regression coefficient if you don't agree with it.
wth rate = 4%
Problem 2
Market value of equity of parent company = 650 ! 1000*10 - 0.1*500 -0.75*400
Debt of parent company = 300 ! 500 -200
Cash of parent company = 50 ! 150 - 100
Enterprise value of parent company = 900
EBITDA of parent company = 150 ! 250 -100
EV/EBITDA for parent company = 6! 900/150
Problem 3
C. Best combination: Low P/BV, Low risk, High growth, High ROE
c.
PBV of C = 1.2 = 0.80 + 0.75 X - 0.5 (1)
Solving for X
ROE for company C would have to be 12%
The ROE would have to be approximately 12%… it is actually 20%
! The book value of capital was missing on this problem. So, I gave full credit to any book
value of capital that was rasonable. The solution assumes that the book value of equity
is $ 1 billion and the book value of capital is $ 2 billion.
000*10 - 0.1*500 -0.75*400 ! Did not net out cash of consolidated sub: -0.5 point
! Got parent EBITDA incorrect: -0.5 to -1 point
! Other computational errors: -0.5 point each
! One point for D and F. They were close but failed one one dimension (D on growth and F on risk)
h and F on risk)
Problem 1
Current price to book ratio = 1.5 Used wrong cost of equity
Current cost of equity = 9% Math error: -0.5 point eac
Expected growth rate= 3%
PBV = 1.5 = (ROE -g)/ (Cost of equity -g)
1.5 = (ROE -.03)/ (.09-.03)
ROE = 12%
Problem 2
Company Primary sharePrice/Share Net Income # Options Value/option
Zap Tech 100 $20 $100 10 $10
InfoRock 500 $6 $150 80 $1.50
Lo Software 80 $5 $20 20 $0.50
Problem 3
Value of private firm = 2000 Used EBIT (1-t) as FCFF:
EBIT (1-t) next year = 300 Reinvestment rate wrong:
Reinvestment rate = 20% ! g/ ROC = 3/15 = 20% Math errors: -0.5 point ea
FCFF next year = 240
Problem 2
SunTrust SouthEast
Market value of equity $150.00 $100.00
Book Value of equity $90.00 $80.00
Expected Net income next year $18.00 $12.00
P/BV 1.666666667 1.25
ROE 20.00% 0.15
Problem 3
Expected EBIT(1-t) 170 ! 200 - 50 (1-.4)
Reinvestment rate = 0% ! Because growth is zero
Value to undiversifed investor = 850
Cost of equity to undiversified investor = 20.00%
Impliws Total Beta = 2.666666667
Correlation with the market = 40%
Market beta = 1.066666667
Cost of equity = 10.400%
Value of business = $ 1,634.62
Sales/Bv oF Capital !Did not compute return on capital: -1 point
! Math errors: -1/2 point
/ (Cost of capital -g)
e higher by 33.33%
Problem 2
Lugano Stulz
Market value of equity 9000 13000 ! EV computed incorrectly:
Book value of equity 4000 6000 ! EBITDA computed incorre
+ Market value of debt 5000 5000 ! Did not consider ROC or ta
Book value of debt 4500 4500
- Cash 1500 2000
- Market value of minority holdings 1500 1000
Book value of minority holdings 500 500
+ Market value of minority interests 1000 3000
Book value of minority interests 400 1000
Tax rate 40% 20%
Net Income 600 1200
Interest expenses 500 500
EBIT 1500 2000 ! Net Income/ (1-t) + Interest expenses
DA 500 1000
Problem 3
PBV = (ROE-g)/(Cost of equity -g)
For publicly traded firms
1.6 = (.12-.04)/ (Cost of equity -.04)
Cost of equity = 9.00%
Given riskfree rate = 4% and ERP =5%
Beta = 1
Total beta = 2.5 ! Beta/ 0.4
Cost of equity = 16.50%
Problem 3
Corrected after-tax EBIT 50
After-tax Operating margin = 0.05
Total Beta = 3 ! 1.2/0.4
Expected growth = 0.1
Estimated EV/Sales = 0.5
Estimated EV = $ 500.00
ll or nothing (Ok if you use (1+g) and get 10.2…)
a. Grading template
Market value of equity = 2200 ! Did not compute curren
+ Debt 800 ! Did not compute EV of
- Cash 500
Enterprise value = 2500
- EV of real estate 1200
- EV of Travel 400
EV of Spa Services 900
EBITDA of Spa Services 120
EV/EBITDA 7.5
b.
Cost of capital = 8% ! Return on capital incorr
Expected growth rate = 2% ! Ignored reinvestment:
Return on capital = 10% ! 100 (1-.4)/600 ! Other errors: -0.5 poin
Reinvestment rate = 20.0%
Intrinsic EV = 816 ! Gave full credit if you got 800 (no (1+g)
Intrinsic EV/EBITDA = 6.8
The business is overvalued at 7.5 times EBITDA
Problem 2
With patent Without patent
Operating margin 15% 7.50% ! Did not back out margi
Return on capital 25% 10% ! Did not compute reinve
Expected growth rate 3% 3% ! Other errors: -0.5 poin
Cost of capital 9% 10%
EV/Sales 2.2 0.75
To solve for the current after-tax margin,
EV/Sales = 2.2 = After-tax margin (1- .03/.25)/(.09-.03)
After-tax operating margin = 15.00%
Problem 3
Forward PE ratio for public firms 12.5 ! Did not back out implie
Cost of equity of public firms = 9.00% ! 3% + 1 (6%) ! Did not compute total b
Expected growth rate = 3.00% ! Did not compute reinve
Implied ROE = 12.00% ! 12.5 = (1- .03/ROE)/ (.09-.03) ! Other math errors: -0.5
ading template
id not compute current EV correctly: -0.5 point
id not compute EV of businesses correctly: -0.5 point
Problem 2
ROE = 12.50% 1. Did not set up to solve for ROE : -1 p
Cost of equity = 10% 2. Did not correct for BV of equity chang
Stable growth rate = 2.50% 3. Math errors: -0.5 point each
Trading PBV= 0.9 (I gave full credit even if you read the q
If PBV = 0.90 = (ROE - .025)/(.10-.025) The PBV ratio then becomes 1.33*0.9 =
Imputed ROE = 9.25% The increase in invested capital is small
Increase in BV of equity = 35.14%
Problem 3
1 2 3 4 5
Revenues $5.00 $7.50 $10.00 $12.00 $12.50
After-tax operating income $2.50 $0.75 $1.25 $1.80 $2.00
FCFF $0.05 $0.25 $0.50 $0.90 $1.20
Terminal value $21.46
Beta 3 3 2 2 1.2
Cost of equity 21.00% 21.00% 15.00% 15.00% 15.00%
Cumulated cost of equity 1.2100 1.4641 1.683715 1.93627225 2.22671309
PV $0.04 $0.17 $0.30 $0.46 $10.18
Value of firm/equity $11.15
Part b
Cost of equity 10.20% 10.20% 10.20% 10.20% 10.20%
PV $0.05 $0.21 $0.37 $0.61 $13.94
Value of firm/equity $15.18
Offering price $14.00
Value gained $1.18
BV of Debt Cash Cost of equity Cost of capital
$2,000 $500 9% 7.50%
$3,000 $500 8% 6.20%
$5,000 $1,000 8.80% 7.00%
return on capital: -1/2 point (Gave full credit if you did not net out cash)
regression equation: -1/2 point
E: -1/2 point
regression equation: -1/2 point
ash in equity value computation: -1/2 point
ebt in equity value computation: -1/2 point
Problem 2
Return on equity = 12.50%
Market value of equity = 6000
Book value of equity = 4000
PBV ratio = 1.5
Problem 3
Expected CF next year = 10
VC's value for the firm = 100
Expected growth rate = 3%
Imputed cost of capital = 13%
Imputed Beta (for VC) = 2
Market Beta = 1.2
Cost of capital = 9.00%
Value of firm in IPO = $166.67
! EV to Inv Cap ratio wrong: -0.5 point
! Equation for EV/Inv Cap wrong: -1 point
! Other math errors: -0.5 point
Problem 2
Next year's Expected
Revenues EBITDA
Best-fit regression
growth(using comparable companies in se
Technology $1,000 $400 15.00% EV/Sales = 1.25 + .5(EBITDA
Hotels $2,000 $200 4.00% EV/EBITDA= 3.30 +42.5(EBIT
Corporate Expenses $0 $75 2.50%
Problem 3
Private retailerPublic retailer
Correlation with the market NA 0.45
Return on equity 20% 10%
Expected growth rate 2.50% 2.50%
Illiquidity Discount 15% NA
Part a
Invested Capital = $800 ! Debt + Equity - Cash - Equity Investment in Caligula
Enterprise value = $1,200 ! Debt + MV of equity - Cash - MV of Equity Investmen
EV/Invested Capital = 1.50
Part b
EV/Invested Capital = (ROC -g)/ (Cost of capital -g)
Cost of capital = 8.00%
Expected growth rate = 2.00%
Return on capital = 11.00%
Problem 2
Division Revenues EBITDA Net Income BV of Equity
Steel $800 $200 $80 $300
Chemicals $600 $200 $120 $200
Finance $600 $350 $100 $250
Total Company $2,000 $750 $300 $750
Problem 3
Comparable (public) companies
Expected
cash flow
Company Business next year Market Beta Correlation with market
Sigma Inc. Technology $80.00 0.8 0.4
Precision Mfg. Manufacturin $25.00 0.8 0.2
Risk free rate = 2.00%
Equity Risk Premium = 5.00%
As stand alone companies to undiversified owners
Company Expected cashTotal Beta Cost of equityValue
Sigma Inc. $80.00 2.00 12.00% $800.00
Precision Mfg. $25.00 4.00 22.00% $125.00
Total $925.00
As a combined company to you
Combined businesses $105.00 1.6 10.0% $1,312.50
Premium over stand alone values = $387.50
As % of value = 41.89%
Grading Template
Problem 2
Most Recent year In year 5
Revenues $ 50 $ 1,000
EBITDA $ (30) $ 80
Debt Outstanding $ - $ 500
Expected growth rate in revenues 80% 15%
Problem 3
Steel Hotels Corporate
Revenues $ 1,000 $ 1,500 $ -
EBITDA $ 150 $ 300 $ (50)
EBIT (1-t) $ 75 $ 150 $ (30)
Cost of capital 8.00%
Steel Hotels Estd Value
Peer Group EV/EBITDA 6.00 8.00
Estimated EV $ 900.00 $ 2,400.00 $ (500.00)
Problem 4
Return on capital = 20.00% ! 10/50
Reinvestment Rate = 10.00% ! g/ROC
EBIT (1-t) next year $ 10.00
FCFF next year $ 9.00
5 years at 20%
$ 2,800.00
Problem 2
Current In year 5
Revenue $ 100.00 $ 1,000.00
After-tax Operating Income $ (20.00) $ 150.00
Book Debt $ 150.00 $ 400.00
Book Equity $ (30.00) $ 600.00
Cash $ 20.00 $ 200.00
Cost of capital 15% 9%
I did not like the following solution, but I gave you full credit, if you stayed consistent
EV/Sales (based on current) = 2.78
EV = $ 277.91
+ Cash $ 20.00
- Debt $ 150.00
Value of equity $ 147.91
Per share $ 0.74
Problem 3
Private company valuation $ 200.00
Cost of equity = 18%
Growth rate forever = 3%
Tax rate 20%
Riskfree rate = 3%
Equity Risk Premium = 6%
First, back out the expected FCFF next year from value
Value = 200 = X/ (.18-.03)
Expected FCFF next year = $ 30.00
Next, adjust this FCFF for missed salaries
Missed Salaries $ 2.50
After-tax Missed Salaries $ 2.00
Adjusted FCFF $ 28.00
Third, compue the total beta from the cost of equity
Cost of equity = 18%
Total Beta = 2.50
Finally, adjust for correlation to get to a market beta
Correlation with the market = 0.3
Market beta = 0.75
Public cost of equity = 7.500%
Finally, get the corrected value
Corrected FCFF 28
Corrected Cost of capital 7.500%
Corrected Value = $ 622.22
d consistent
Grading Template