Collection of formulas

Multi-stage models:

1+𝑔 ℎ 𝐶𝐹𝑛+ℎ (1 + 𝑔𝐿 )
𝐶𝐹𝑛 (1 + 𝑔𝑆 ) [1 − ( 1 + 𝑟𝑆 ) ]
𝑆 (𝑟𝐿 − 𝑔𝐿 )
𝑉𝑛 = +
𝑟𝑆 − 𝑔𝑆 (1 + 𝑟𝑆 )ℎ

𝐶𝐹𝑛 (𝑔𝑆 − 𝑔𝐿 )𝐻 𝐶𝐹𝑛 (1 + 𝑔𝐿 )

𝑉𝑛 = +
𝑟 − 𝑔𝐿 𝑟 − 𝑔𝐿

1+𝑔 ℎ 𝐶𝐹𝑛 (𝑔𝑆 − 𝑔𝐿 )𝐻 𝐶𝐹𝑛 (1 + 𝑔𝐿 )

𝐶𝐹𝑛 (1 + 𝑔𝑆 ) [1 − ( 1 + 𝑟𝑆 ) ] + 𝑟−𝑔
𝑟 − 𝑔𝐿 𝐿
𝑉𝑛 = + ℎ
𝑟 − 𝑔𝑆 (1 + 𝑟)

Value-driver models:

𝑔
𝑁𝑂𝑃𝐴𝑇𝑛+1 (1 − 𝑅𝑂𝑁𝐼𝐶 )
𝑉𝑛,𝐹𝐶𝐹𝐹 =
𝑊𝐴𝐶𝐶 − 𝑔

𝑔
𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒𝑛+1 (1 − 𝑅𝑂𝐸 )
𝑁
𝑉𝑛,𝐹𝐶𝐹𝐸 =
𝑟−𝑔

𝑔
𝐸𝑃𝑛 𝑁𝑂𝑃𝐴𝑇𝑛+1 (𝑅𝑂𝑁𝐼𝐶 ) (𝑅𝑂𝑁𝐼𝐶 − 𝑊𝐴𝐶𝐶)
𝑉𝑛,𝐸𝑃 = +
𝑊𝐴𝐶𝐶 𝑊𝐴𝐶𝐶(𝑊𝐴𝐶𝐶 − 𝑔)

𝑔
𝑅𝐼𝑛 𝑁𝐼𝑛+1 (𝑅𝑂𝐸𝑁 ) (𝑅𝑂𝐸𝑁 − 𝑟)
𝑉𝑛,𝑅𝐼 = +
𝑟 𝑟(𝑟 − 𝑔)
Question 1 (10 points)
On the following multiple choice questions, mark the answer you consider to be most correct
by drawing a circle around the number (i, ii, iii, etc) of your preferred alternative. Do not
motivate your answers.

a) You have determined that the appropriate EV/EBITDA for a firm is 8.4. Given the following
information the value of equity for the firm is closest to: (2 points)

Market value of Cash

EBITDA debt
7,000 32,000 2,000

(i) 27,000
(ii) 29,000
(iii) 59,000
(iv) 61,000
(v) 91,000
(vi) There is not sufficient information provided to respond

b) The book value of equity of a firm with the following information is closest to: (2 points)

Number of shares
outstanding Price per share Total assets Total liabilities Net income
1,500 135 540,000 350,000 160,000

(i) 122,500
(ii) 190,000
(iii) 350,000
(iv) 472,500
(v) 540,000
(vi) There is not sufficient information provided to respond

c) High P/E ratios tend to indicate that a firm is expected to ______, ceteris paribus. (2 points)

(i) grow quickly

(ii) grow at the same rate as the average firm
(iii) grow slowly
(iv) not grow
(iv) There is not sufficient information provided to respond

d) Industry consolidation and high barriers to entry most likely characterize which life-cycle
stage? (2 points)

(i) Embryonic
(ii) Growth
(iii) Shakeout
(iv) Mature
(v) Decline
 (vi) There is not sufficient information provided to respond

e) If a firm’s long-run average cost of production increases by 15% from an 8% increase in

production the firm is most likely experiencing: (2 points)

(i) economies of scale

(ii) diseconomies of scale
(iii) constant returns to scale

Question 2 (12 points)

Remember to show all your calculations.

a) Alfa’s per-share end-of-year book value of equity for 2020 was $11.17. In late October
2021, analysts were forecasting consensus earnings per share of $1.55 for 2021. They were
also forecasting a dividend per share for 2021 of $0.68. You consider the firm to be mature,
so decide to value Alfa using single-stage models. Value the firm using the dividend
discount model and the FCFE model, assuming a required return on equity of 10% and a
growth rate of 4%. (6 points)

b) Are your forecasts and assumptions in a) consistent with your decision to use single-stage
models? (3 points)

c) In late October 2021, Alfa traded at $22.91. Assume that you believe in all forecasts in
question a) except the growth rate. Assuming that the market value correctly reflects
fundamental value, which growth rate does the market seem to forecast? (3 points)

Question 3 (8 points)
Remember to show all your calculations.

a) Alloy Mills is currently reporting a net income of $100mn. The firm has a return on equity
(ROE) of 20%, a cost of equity of 10%, and reinvests 50% of its earnings back into the firm.
After year 5, the firm is expected to reduce the reinvestment rate to 25% while the return on
equity is expected to stay at 20%. What is the value of the firm? (6 points)

b) How would the value of Alloy Mills change if we change the return on equity (ROE) in
stable growth to 10% while keeping other predictions as in (a)? (2 points)

Question 4 (10 points)

Remember to show all your calculations.

You have the following information for a firm (today is t=0):

NOPATt=1 Growth RONIC WACC

Automotive 100 5% 20% 10%

a) Using a single-stage model, what is the value of the firm? (3 points)

b) The firm has invested capital of 500. What is the economic profit (EP) for year (t=1)? If you
did not solve (i), make necessary assumptions. (3 points)
c) Value the firm using the economic profit model. (4 points)

Question 5 (10 points)

Remember to show all your calculations.

You have the following information for the firm Delta and its closest peers (all numbers are in
€ millions):

Delta Peers
Revenue 46.00 54.00
Earnings before interest and taxes 6.00 9.00
Earnings before taxes 4.75 5.75
Net income 2.88 3.00
Total assets 123.00 145.00
Total equity 16.00 15.00

a) Based on the information in the table, what best explains Delta’s lower return on equity
(ROE) compared to peers? (4 points)

b) How large a dividend payout would it take for Delta to bring their return on equity (ROE)
up to the level of peers? (2 points)

c) Based on the information in the table, what best explains Delta’s higher net profit margin
compared to peers? (4 points)

General comment on the example exam: the example exam is inspired by in-text examples
and end of chapter questions in Pinto, so these are useful to work with to prepare for the exam.
Answers to example exam
Question 1
a) ii (8.47,000-32,000+2,200 = 29,000)

b) ii (540,000-350,000 = 190,000)

c) i (investors pay for growth, hence the high P/E ratio for growth firms)

d) iv (these are two characteristics of a mature-stage industry)

e) ii (with economies of scale (constant returns to scale), we would expect average cost to go
down (remain the same) with production expansion)

Question 2
a) DDM: 0.68/(0.10-0.04) = 11.33
FCFE: Net income = 1.55; Investment = growth in BV equity
BV equity forecasted for 2021 = BV Equityboy + Net income – Dividends = 11.17 + 1.55
– 0.68 = 12.04
 Investment = 12.04 – 11.17 = 0.87
 FCFE = 1.55 – 0.87 = 0.68
 FCFE = 0.68/(0.10-0.04) = 11.33

b) Sustainable growth rate, g = b×ROE

ROE = 1.55/11.17 = 13.9%
b = 1 – 0.68/1.55 = 56.1%
 g = 0.139×0.561 = 7.8%, so no, the growth forecast is not consistent with sustainable
growth

c) DDM: 0.68/(0.10-g) = 22.91  g = 0.10 – 0.68/22.91 = 0.07

Question 3
a) gyear 1-5 = 0.20×0.50 = 0.10
Expected dividends in the coming five years:
Year 1 = 100×1.10×0.50 = 50×1.1 = 55.00mn
Year 2 = 100×1.102×0.50 = 50×1.12 = 60.50mn
Year 3 = 100×1.103×0.50 = 50×1.13 = 66.55mn
Year 4 = 100×1.104×0.50 = 50×1.14 = 73.21mn
Year 5 = 100×1.105×0.50 = 50×1.15 = 80.53mn

Year Today 1 2 3 4 5
2 3 4
Dividends (mn)50 50×1.1 50×1.1 50×1.1 50×1.1 50×1.15
r 10% 10% 10% 10% 10%
PV 50×1.1/1.1 50×1.1 /1.1 50×1.1 /1.1 50×1.1 /1.1 50×1.1 /1.15
2 2 3 3 4 4 5

Sum(PV) = 50×5 = 250mn

gyear 6 = 0.20×0.25 = 0.05
Dividends, year 6 = 100×1.105×1.05×0.75 = 126.83mn
TV = 126.83/(0.10-0.05) = 2,536.55mn
PV(TV) = 2,536.55/1.15 = 1,575mn
V = 250+1,575 = 1,825mn
b) New gyear 6 = 0.10×0.25 = 0.025
Dividends, year 6 = 100×1.105×1.025×0.75 = 123.81mn
TV = 123.81/(0.10-0.025) = 1,650.77mn
PV(TV) = 1,650.77/1.15 = 1,025mn
V = 250+1,025 = 1,275mn

Question 4
a) 100×(1 – (5%/20%)) / (10%-5%) = 1,500

b) EP = NOPAT – IC×WACC = 100-500×0.1=50

c) V = IC + EPt=1/(WACC-g) = 500 + 50/(0.1-0.05) = 1,500.

Question 5
a) ROE = ROE = NI/S×S/TA×TA/E
Delta = 2.88/46×46/123×123/16 = 0.063×0.37×7.69 = 18%
Peers = 3/54×54/145×145/15 = 0.056×0.37×9.67 = 20%
The main difference is the lower leverage (the equity multiplier) and, to a minor extent, the
net profit margin.

b) Delta’s ROE = 2.88/target E = 20%  target E = 14.4, so a payout of 16-14.4 = 1.6.

c) We can analyze NI/EBT, EBT/EBIT, and EBIT/Revenue

Delta: 2.88/4.75 = 0.606; 4.75/6 = 0.792; 6/46 = 0.130
Peers: 3/5.75 = 0.522; 5.75/9 = 0.639; 9/54 = 0.167
The main differences lie in taxes paid and interest expenses, both of which are lower for
Delta.