Download - 04 Free Cash Flow Valuation
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TestID:7441130FreeCashFlowValuation
Question#1of145 QuestionID:463221
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AnanalysthaspreparedthefollowingscenariosforSchneider,Inc.:
Scenario1Assumptions:
Taxrateis40%.Weightedaveragecostofcapital(WACC)=12%.Constantgrowthrateinfreecashflow=3%.Lastyear,freecashflowtothefirm(FCFF)=$30.Targetdebtratio=10%.
Scenario2Assumptions:
Taxrateis40%.Expensesbeforeinterestandtaxes(EBIT),capitalexpenditures,anddepreciationwillgrowat15%forthenextthreeyears.Afterthreeyears,thegrowthinEBITwillbe2%,andcapitalexpenditureanddepreciationwilloffseteachother.WACCduringhighgrowthstage=20%.WACCduringstablegrowthstage=12%.Targetdebtratio=10%.
Scenario2FCFF
Year0
(last
year)
Year1 Year2 Year3 Year4
EBIT $15.00 $17.25 $19.84 $22.81 $23.27
CapitalExpenditures 6.00 6.90 7.94 9.13
Depreciation 4.00 4.60 5.29 6.08
ChangeinWorkingCapital 2.00 2.10 2.20 2.40 2.40
FCFF 5.95 7.06 8.25 11.56
AssumingthatSchneider,Inc.,slightlyincreasesitsfinancialleverage,whatshouldhappentoitsfirmvalue?Thefirmvalueshould:
increaseduetotheadditionalvalueofinteresttaxshields.
notchangebecausefinancialleveragehasnorelationshipwithfirmvalue.
declineduetotheincreaseinrisk.
Explanation
Forsmallchangesinleverage,theadditionalvalueaddedbytheinteresttaxshieldswillmorethanoffsettheadditionalriskofbankruptcy
/financialdistress.Giventhetaxadvantageofdebt,thefirm'sWACCshoulddecline,notincreasewithsmallchangesinleverage.
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Questions#27of145
Question#2of145 QuestionID:463279
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Question#3of145 QuestionID:463280
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HarrisburgTireCompany(HTC)forecaststhefollowingfor2013:
Earnings(netincome)=$600M.
Dividends=$120M.
Interestexpense=$400M.
Taxrate=40.0%.
Depreciation=$500M.
Capitalspending=$800M.
Totalassets=$10B(bookvalueandmarketvalue).
Debt=$4B(bookvalueandmarketvalue).
Equity=$6B(bookvalueandmarketvalue).
Targetdebttoassetratio=0.40.
Sharesoutstanding=2.0billion
Thefirm'sworkingcapitalneedsarenegligible,andHTCplanstocontinuetooperatewiththecurrentcapitalstructure.Thetireindustry
demandishighlydependentondemandfornewautomobiles.Individualcompaniesintheindustrydon'thavemuchinfluenceonthe
designofautomobilesandhaveverylittleabilitytoaffecttheirbusinessenvironment.Thedemandfornewautomobilesishighlycyclical
butdemandforecasterrorstendtobelow.
Thefirm'searningsgrowthrateismostaccuratelyestimatedas:
6.4%.
4.8%.
8.0%.
Explanation
Thefirm'sestimatedearningsgrowthrateistheproductofitsretentionratioandROE:
g=RR(ROE)=[(600120)/600](600/6000)=0.08(LOS35.o)
The2013forecastedfreecashflowtoequityis:
$300M.
$420M.
$340M.
Explanation
Sinceworkingcapitalneedsarenegligible,thefreecashflowtoequityis:
FCFE=Netincome[1DR)][FCInvDepreciation][(1DR)WCInv]FCFE=600M[10.4](800M500M)=420M
where:DR=targetdebttoassetratio(LOS36.d)
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Question#4of145 QuestionID:463281
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Question#5of145 QuestionID:463282
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Question#6of145 QuestionID:463283
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Question#7of145 QuestionID:463284
Ifthetotalmarketvalueofequityis$6.0billionandthegrowthrateis8.0%,thecostofequitybasedonthestablegrowthFCFEmodelis
closestto:
15.0%.
7.6%.
15.6%.
Explanation
Valueofequity=FCFE /(Costofequitygrowthrate)so$6,000=[$420(1.08)]/(Costofequity0.08)
(Costofequity0.08)$6,000=$453.6
Costofequity0.08=0.0756
Costofequity=0.1556=15.56%(LOS36.j)
ThebetaforHTCis1.056,theriskfreerateis5.0%andthemarketriskpremiumis10.0%.TheweightedaveragecostofcapitalforHTC
isclosestto:
11.74%.
13.34%.
15.56%.
Explanation
Costofequity=r +(r r )=0.05+1.056(0.10)=0.05+0.1056=0.1556
Thebestapproximationforcostofdebtistheinterestexpensedividedbythemarketvalueofthedebt.
Costofdebt=Interestexpense/marketvalueofdebt=$400million/$4.0billion=0.10
WACC=w r (1t)+were=0.400.10(10.40)+0.600.1556=0.1174(LOS36.j)
ThemostappropriatestrategyformulationstyleforHTCis:
Adaptive
Classical
Shaping
Explanation
Industrydemandiscyclicalbutforecasterrorstendtobelowindicatingpredictablebusinessenvironment.Wearealsogiventhat
malleabilityislow.HenceClassicalstylewouldbemostappropriate.(LOS33.c)
FCFEfor2013is$400.0millionandHTCtookonanadditionaldebtof$40.0millionwhilerepayingexistingdebtof$60.0million.ThegrowthrateforFCFFis5.0%andtheWACCis11.5%.Thevalueofthefirmcalculatedusingthestablegrowthmodelismostaccuratelydescribedas:
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d d
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Question#8of145 QuestionID:463199
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Question#9of145 QuestionID:463244
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Question#10of145 QuestionID:463232
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lessthanthemarketvalueofthefirmby$3.3billion.
lessthanthemarketvalueofthefirmby$7.5billion.
greaterthanthemarketvalueofthefirmby$0.7billion.
Explanation
FCFF=FCFE+Interestexpense(1t)netborrowing=$400million+$400million(10.40)($40million$60million)=$660million.Valueofthefirm=[$660million(1.05)]/(0.1150.05)=$10.662billion.Thisisadifferenceof$0.662billioncomparedtothe$10.0billioncurrentmarketvalue.(LOS36.j,m)
Afirmcurrentlyhassalespershareof$10.00,andexpectssalestogrowby25%nextyear.Thenetprofitmarginisexpectedtobe15%.
Fixedcapitalinvestmentnetofdepreciationisprojectedtobe65%ofthesalesincrease,andworkingcapitalrequirementsare15%ofthe
projectedsalesincrease.Debtwillfinance45%oftheinvestmentsinnetcapitalandworkingcapital.Thecompanyhasan11%required
rateofreturnonequity.Whatisthefirm'sexpectedfreecashflowtoequity(FCFE)persharenextyearundertheseassumptions?
$0.38.
$1.88.
$0.77.
Explanation
FCFE=netprofitNetFCInvWCInv+DebtFin=$1.88$1.630.38+0.90=0.77
InusingFCFEmodels,theassumptionofgrowthshouldbe:
independentfromtheassumptionsofothervariables.
onlyconsistentwiththeassumptionsofcapitalspendinganddepreciation.
consistentwithassumptionsofothervariables.
Explanation
Theassumptionofgrowthshouldbeconsistentwithassumptionsaboutothervariables.Netcapitalexpenditures(capitalexpendituresminusdepreciation)andbeta(risk)usedtocalculaterequiredrateofreturnshouldbeconsistentwithassumedgrowthrate.
WhichofthefollowingstatementsaboutthethreestageFCFEmodelismostaccurate?
Thereisafinalphasewhengrowthratestartstodecline.
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Questions#1116of145
Thereisatransitionperiodwherethegrowthratedeclines.
Thereisatransitionperiodwherethegrowthrateisstable.
Explanation
InthethreestageFCFEmodel,thereisaninitialphaseofhighgrowth,atransitionperiodwherethegrowthratedeclines,andasteadystateperiodwheregrowthisstable.
MichaelBallmerisanequityanalystwithNewHorizonResearch.Thefirmhashistoricallyreliedondividendandresidualincomevaluationmodelstovalueequity,butthefirm'sdirectorofresearch,DougLeads,hasdecidedthatthefirmneedstoincorporatefreecashflowvaluationsintoitspractices.Therefore,LeadsdecidestosendBallmertoaseminaronfreecashflowvaluation.
Uponhisreturnfromtheconvention,Ballmerisexcitedtosharehisnewfoundknowledgewithhiscoworkers.BallmerisaskedtogiveadebriefingtoNewHorizon'steamofequityanalysts,wherehemakesthefollowingstatements:
Statement1:
Freecashflowtothefirmistheamountofthefirm'scashflowthatisfreeforthefirmtouseinmakinginvestmentsaftercashoperating
expenseshavebeencovered.
Statement2:
Freecashflowtoequity,then,istheamountofthefirm'scashflowthatisfreeforequityholdersaftercoveringcashoperatingexpenses,
workingcapitalandfixedcapitalinvestments,interestprincipalpaymentstobondholders,andrequireddividedpayments.
Statement3:
Oneofthebenefitsoffreecashflowvaluationisthatthevalueofthefirmandthevalueofequitycanbefoundbydiscountingfreecashflowtothefirmandfreecashflowtoequity,respectively,bythe
WACC.
Aspartofhispresentation,Ballmerincludesashortexampleofhowtocalculatefreecashflowtoequity.Thefiguresfromhisexampleareincludedbelow.
Figure1:ExampleBalanceSheet
20X2 20X1
Cash $632 $245
Accountsreceivable $208 $105
Inventory $8,249 $8,209
Currentassets $9,089 $8,559
GrossPPE $22,499 $22,722
Accumulateddepreciation ($3,251) ($2,875)
Totalassets $28,337 $28,406
Accountspayable $4,864 $4,543
Shorttermdebt $2,491 $2,996
Currentliabilities $7,355 $7,539
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Question#11of145 QuestionID:463179
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Question#12of145 QuestionID:463180
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Longtermdebt $4,528 $5,039
Commonstock $729 $735
Retainedearnings $15,725 $15,093
Totalliabilitiesandowner'sequity
$28,337 $28,406
Figure2:ExampleCashFlowFromOperations
20X2 20X1
Netincome $1,783 $2,195
Depreciation $376 $267
WCInv ($178) $357
Cashflowfromoperations
$2,337 $2,819
Afterdiscussingthecalculationoffreecashflowtothefirmandfreecashflowtoequityfromhistoricalinformation,Ballmerproceedstoexplainthemajorapproachesforforecastingfreecashflow.Hefocuseshisdiscussiononforecastingthecomponentsoffreecashflowasthismethodismoreflexible.Duringhispresentation,severaloftheanalystsnoticethattheformulaforforecastingfreecashflowtoequitydoesnotincludenetborrowing.TheybringthistoBallmer'sattention,andhestatesthathewilllookintotheformulaandsendoutanupdatedpresentationafterthemeeting.
Aweekafterthemeeting,JonathanHodgesapproachedBallmerregardingtwoissueshehadwhileapplyingfreecashflowbasedvaluations.ThefirstissuethatHodgeshadwasthathecalculatedtheequityvalueofafirmusingbothfreecashflowtoequitybasedanddividendbasedvaluationsandarrivedatdifferentvalues.ThesecondissuethatHodgescameacrosswastheeffectofachangeinafirm'stargetleverageonFCFE.OneofthefirmsthatHodgeswasanalyzingmayreduceleverage,andHodgesneedstoknowifthiswillaffecthisvaluation.
Regardingstatements1and2,areBallmer'sinterpretationsoffreecashflowtothefirm(FCFF)andfreecashflowtoequity(FCFE)CORRECT?
No,neitherinterpretationiscorrect.
No,onlyoneinterpretationiscorrect.
Yes,bothinterpretationsarecorrect.
Explanation
Freecashflowtothefirm(FCFF)isthecashflowsthatarefreetoinvestorsaftercashoperatingexpenses(includingtaxesbutexcludinginterestexpense),workingcapitalinvestments,andfixedcapitalinvestmentshavebeenmade.Freecashflowtoequity(FCFE)isFCFFlessinterestpaymentstobondholdersandnetborrowingfrombondholders.(StudySession12,LOS36.a)
IsBallmer'sthirdstatementregardingthecomputationoffirmvalueandequityvalueCORRECT?
Yes.
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Question#13of145 QuestionID:463181
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Question#14of145 QuestionID:463182
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Question#15of145
No,freecashflowtoequityshouldbediscountedattherequiredreturnonequity.
No,bothfreecashflowtothefirmandfreecashflowtoequityshouldbediscountedattherequiredrateofreturnonequity.
Explanation
Thevalueofafirmistheexpectedfuturefreecashflowtothefirm(FCFF)discountedatthefirm'sweightedaveragecostofcapital(WACC).Thevalueofthefirm'sequityistheexpectedfuturefreecashflowtoequitydiscountedattherequiredreturnonequity.(StudySession12,LOS36.d)
Basedonfigures1and2,the20X2freecashflowtoequity(FCFE)forBallmer'sexamplefirmis:
$1,010.
$1,693.
$1,544.
Explanation
Freecashflowtoequity(FCFE)canbecomputedas:
FCFE=CFOFCInv+netborrowing
Basedonthefiguresincludedintheexample,fixedcapitalinvestment(FCInv)is$223(=$22,499$22,722)andnetborrowingis$1,016(=$2,491+$4,528$2,996$5,039).
FCFEistherefore:FCFE=$2,337+$223$1,016=$1,544.(StudySession12,LOS36.d)
WhichofthefollowingstatementsregardingforecastingFCFEusingthecomponentsoffreecashflowmethodandnetborrowingismostaccurate?
Investmentinfixedcapitalandnetborrowingareassumedtooffseteachother.
Netincomealreadyaccountsforinterestexpensetherefore,netborrowingisnotneeded.
Thetargetdebttoassetratioaccountsforthefinancingofnewinvestmentinfixedcapitalandworkingcapital.
Explanation
WhenforecastingFCFE,itiscommontoassumethatafirmwillmaintainatargetdebttoassetratiofornewinvestmentsinfixedcapitalandworkingcapital.Basedonthisassumption,theformulaforforecastingFCFEis:
FCFE=NI&8722[(1DR)(FCInvDep)][(1DR)WCInv]
Bymultiplyingthefixedcapitalandworkingcapitalinvestmentsbyoneminusthetargetdebttoassetratio,youareleftwiththeinvestmentamountlesstheamountfinancedbydebt,whichisthenetborrowingamount.Therefore,thisformulaaccountsfornetborrowingthroughthetargetdebttoassetratio.(StudySession12,LOS36.e)
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QuestionID:463183
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Question#16of145 QuestionID:463184
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Question#17of145 QuestionID:463243
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Question#18of145 QuestionID:463225
Shoulddividendbasedandfreecashflowfromequity(FCFE)basedvaluationsresultindifferentequityvaluesforafirm?
Yes,dividendbasedvaluationswouldbehigherforfirmswithlarge,consistentdividends.
Yes,thefreecashflowfromequityvaluationwouldbehigheriftherewereapremiumassociatedwithcontrolofthefirm.
No,bothmodelsshouldresultinthesamevalue.
Explanation
TheownershipperspectivesofdividendbasedandFCFEbasedvaluationsaredifferent.Dividendbasedvaluationstaketheperspectiveofminorityshareholders,whileFCFEbasedvaluationstaketheperspectiveofanacquirerwhowillassumeacontrollingpositioninthefirm.Ifinvestorswerewillingtopayapremiumforacontrollingpositioninthefirm,thentheequityvaluecomputedundertheFCFEapproachwouldbehigher.(StudySession12,LOS36.b)
Whichofthefollowingstatementsregardingtheeffectadecreaseinleveragehasonafirm'sfreecashflowfromequity(FCFE)ismostaccurate?
FCFEisunaffectedbychangesinleverage.
CurrentyearFCFEincreases,butfutureFCFEwillbereduced.
CurrentyearFCFEdecreases,butfutureFCFEwillbeincreased.
Explanation
ChangesinleveragedohaveasmalleffectonFCFE.AdecreaseinleveragewillcausethecurrentyearFCFEtodecreasethroughtherepaymentofdebt.FutureFCFEwillbeincreasedbecauseinterestexpensewillbelower.(StudySession12,LOS36.g)
Athreestagefreecashflowtothefirm(FCFF)istypicallyappropriatewhen:
growthiscurrentlylowandwillmovethroughatransitionalstagetoafinalstage
whereingrowthexceedstherequiredrateofreturn.
growthiscurrentlyhighandwillmovethroughatransitionalstagetoasteadystategrowth
rate.
therequiredrateofreturnislessthanthegrowthrateinthelaststage.
Explanation
ThethreestagemodelusingeitherFCFEorFCFFtypicallyassumesthatgrowthiscurrentlyhighandwillmovethroughatransitional
stagetoasteadystategrowthrate.Multistagemodelsassumethattherequiredrateofreturnexceedsthegrowthrateinthelaststage.
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Questions#1924of145
Whichofthefollowingstatementsregardingdividendsandfreecashflowtoequity(FCFE)isleastaccurate?
FCFEcanbenegativebutdividendscannot.
RequiredreturnsarehigherinFCFEdiscountmodelsthantheyareindividenddiscount
models,sinceFCFEismoredifficulttoestimate.
FCFEdiscountmodelsusuallyresultinhigherequityvaluesthandodividenddiscountmodels
(DDMs).
Explanation
AlthoughFCFEmaybemoredifficulttoestimatethandividends,therequiredreturnisbasedontheriskfacedbytheshareholders,which
wouldbethesameunderbothmodels.
AnanalysthaspreparedthefollowingscenariosforSchneiderInc.:
Scenario1Assumptions:
TaxRateis40%.Weightedaveragecostofcapital(WACC)=12.0%.Constantgrowthrateinfreecashflow(FCF)=3.0%.Year0,freecashflowtothefirm(FCFF)=$30.0millionTargetdebtratio=10.0%.
Scenario2Assumptions:
TaxRateis40.0%.Expensesbeforeinterestandtaxes(EBIT),capitalexpenditures,anddepreciationwillgrowat20.0%forthenextthreeyears.Afterthreeyears,thegrowthinEBITwillbe2.0%,andcapitalexpenditureanddepreciationwilloffseteachother.Weightedaveragecostofcapital(WACC)=12.0%Targetdebtratio=10.0%.
Scenario2FCFF(in$millions)Year0
Year0
Year1 Year2 Year3 Year4
EBIT $45.00 $54.00 $64.80 $77.76 $79.70
CapitalExpenditures 18.00 21.60 25.92 31.10
Depreciation 12.00 14.40 17.28 20.74
ChangeinWorkingCapital 6.00 6.30 6.60 7.20 7.20
FCFF 18.90 23.64 29.09 40.62
OtherfinancialitemsforSchneiderInc.:
Estimatedmarketvalueofdebt=$35.0millionCostofdebt=5.0%Sharesoutstanding=20million.
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Question#19of145 QuestionID:463248
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Question#20of145 QuestionID:463249
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Question#21of145 QuestionID:463250
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Question#22of145 QuestionID:463251
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GiventheassumptionscontainedinScenario1,thevalueofthefirmismostaccuratelyestimatedas:
$343million.
$250million.
$333million
Explanation
UnderthestablegrowthFCFFmodel,thevalueofthefirm=FCFF /(WACCg )=$30million(1.03)/(0.120.03)=$343.33million.
(LOS36.j)
InScenario2,theyear0freecashflowtothefirm(FCFF)isclosestto
$15million.
$16million.
$27million.
Explanation
FCFF=EBIT(1taxrate)+DepreciationCapitalExpendituresChangeinWorkingCapital=45.0(10.4)+12.018.06.0=15.00.
(LOS36.d)
InScenario2,thepresentvalueoftheterminalvalueisclosestto:
$289million.
$347million.
$258million.
Explanation
Theterminalvalueis:FCFFforyear4/(WACCgrowthrate)=$40.62/(0.120.02)=$406.22millionintermsofyear3dollars.Thecalculatorinputstosolveforthepresentvalueis:FV=$406.22,N=3,I/Y=12solveforPV.PVis$289.14Million.(LOS36.e)
(LOS36.e)
InScenario2,thevalueofthefirmisclosestto:
$315million.
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Question#23of145 QuestionID:463252
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Question#24of145 QuestionID:463253
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Question#25of145 QuestionID:463185
$346million.
$321million.
Explanation
ThevalueofthefirmisthepresentvalueofYear13plustheterminalvalue.Theterminalvalueis:FCFFforyear4/(WACCgrowthrate)=$40.62/(0.120.02)=$406.22millionintermsofyear3dollars.ThecalculatorinputstosolveNPVforthevalueofthefirmis:CF0=$0,CF1=$18.90,CF2=$23.64,CF3=$29.09+$406.22=$435.31,I=12.NPV=$345.57million.
(LOS36.d)
ThecostofequityforSchneiderInc.isclosestto:
13.0%.
5.8%.
11.3%
Explanation
TheweightedaveragecostofcapitalformulaisWACC=w r (1t)+w r .Theweightofdebtis10.0%theweightofequitymustbe90.0%.
0.12=0.100.05(10.40)+0.90r 0.1200.003=0.90r 0.117/0.9=r r =13.0%
(LOS36.j)
ThemarketvalueofScheiderInc.'sstockis:
$17.50pershare.
$15.75pershare
$31.50pershare.
Explanation
Theestimatedmarketvalueofdebtis$35million,whichrepresents10.0%ofthevalueofthefirm.Theother90.0%isthevalueofequityor$315million.$315million/20millionshares=$15.75pershare.
(LOS36.j)
Ananalystisperforminganequityvaluationforaminorityequitypositioninadividendpayingmultinational.Theappropriatemodelforthisanalysisismostlikely:
d d e e
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e
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Question#26of145 QuestionID:463217
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Questions#2732of145
FCFEapproach.
TheDividendDiscountapproach.
FCFFapproach.
Explanation
Thedividenddiscountmodelismostappropriateforvaluingaminorityequitypositioninadividendpayingcompany.Thefreecashflowapproachlookstothesourceofdividendsfromtheperspectiveofanownerthathascontrolratherthandirectlyatdividends.
Anincreaseinfinancialleveragewillcausefreecashflowtoequity(FCFE)to:
increaseintheyeartheborrowingoccurred.
decreaseintheyeartheborrowingoccurred.
decreaseorincrease,dependingonitscircumstances.
Explanation
Anincreaseinfinancialleveragewillincreasenetborrowingand,hence,increaseFCFEintheyeartheborrowingoccurredbecause:
FCFE=FCFF[interestexpense](1taxrate)+netborrowing.
BurcarEckhardt,afirmspecializinginvalueinvestments,hasbeenapproachedbythemanagementofOverhaulTrucking,Inc.,toexplorethepossibilityoftakingthefirmprivateviaamanagementbuyout.Overhaul'sstockhasstumbledrecently,inlargepartduetoasuddenincreaseinoilprices.Managementconsidersthisanopportunetimetotakethecompanyprivate.Burcarwouldbeaminorityinvestorinagroupoffriendlybuyers.
JaimieCarson,CFA,isaprivateequityportfoliomanagerwithBurcar.HehasbeenaskedbyThelmaEckhardt,CFA,oneofthefirm'sfoundingpartners,totakealookatOverhaulandcomeupwithastrategyforvaluingthefirm.AfteranalyzingOverhaul'sfinancialstatementsasofthemostrecentfiscalyearend(presentedbelow),hedeterminesthatavaluationusingFreeCashFlowtoEquity(FCFE)ismostappropriate.HealsonotesthattherewerenosalesofPPE.
OverhaulTrucking,Inc.
IncomeStatement
April30,2005
(Millionsofdollars)
2005 2006E
Sales 300.0 320.0
GrossProfit 200.0 190.0
SG&A 50.0 50.0
Depreciation 70.0 80.0
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EBIT 80.0 60.0
InterestExpense 30.0 34.0
Taxes(at35percent) 17.5 9.1
NetIncome 32.5 16.9
OverhaulTrucking,Inc.
BalanceSheet
April30,2005
(Millionsofdollars)
2005 2006E
Cash 10.0 15.0
AccountsReceivable 50.0 55.0
GrossProperty,Plant&Equip. 400.0 480.0
AccumulatedDepreciation (160.0) (240.0)
TotalAssets 300.0 310.0
AccountsPayable 50.0 70.0
LongTermDebt 140.0 113.1
CommonStock 80.0 80.0
RetainedEarnings 30.0 46.9
TotalLiabilities&Equity 300.0 310.0
EckhardtagreeswithCarson'schoiceofvaluationmethod,butherconcernisOverhaul'sdebtratio.Considerablyhigherthantheindustryaverage,Eckhardtworriesthatthefirm'sheavyleverageposesarisktoequityinvestors.OverhaulTruckingusesaweightedaveragecostofcapitalof12%forcapitalbudgeting,andEckhardtwondersifthat'srealistic.
EckhardtasksCarsontodoavaluationofOverhaulinahighgrowthscenariotoseeifoptimisticestimatesofthefirm'sneartermgrowthratecanjustifytherequiredreturntoequity.Forthehighgrowthscenario,sheaskshimtostartwithhis2006estimateofFCFE,growitat30%peryearforthreeyearsandthendecreasethegrowthrateinFCFEinequalincrementsforanotherthreeyearsuntilithitsthelongrungrowthrateof3%in2012.EckhardttellsCarsonthatthereturnstoequityBurcarEckhardtwouldrequireare20%untilthecompletionofthehighgrowthphase,15%duringthethreeyearsofdeclininggrowth,and10percentthereafter.EckhardtwantstoknowwhatBurcarcouldaffordtopayfora15%stakeinOverhaulinthishighgrowthscenario.
CarsonassemblesafewspreadsheetsandtellsEckhardt,"Wecouldmakeabidofjustunder$16millionforthestakeinOverhaulifthehighgrowthscenarioplaysout."Eckhardtworries,though,thatthevalueoftheirbidisextremelysensitivetotheassumptionforterminalgrowth,sinceinthatscenario,theterminalvalueofthefirmaccountsforslightlymorethantwothirdsofthetotalvalue.
Carsonagrees,andproposesdoingavaluationundera"sustainedgrowth"scenario.HisestimatesshowOverhaulgrowingFCFEbythefollowingamounts:
2007 2008 2009 2010 2011
GrowthinFCFE 40.0% 15.7% 8.6% 9.1% 8.3%
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Question#27of145 QuestionID:463300
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Question#28of145 QuestionID:463301
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Question#29of145 QuestionID:463302
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Inthisscenario,hewouldprojectsustainedgrowthof6%peryearin2012andbeyond.Withthemorestablegrowthpatternincashflow,EckhardtandCarsonagreethattherequiredreturntoequitycouldbecuttoamoremoderate12%.
CarsonalsodecidestotryvaluingthefirmonFreeCashFlowtotheFirm(FCFF)usingthissame12%requiredreturn.Usingasinglestagemodelontheestimated2006figurespresentedinthefinancialstatementsabove,hecomesupwithavaluationof$1.08billion.
WhichofthefollowingisoneofthedifferencesbetweenFCFEandFCFF?FCFFdoesnotdeduct:
workingcapitalinvestment.
operatingexpenses.
interestpaymentstobondholders.
Explanation
FCFFincludesthecashavailabletoallofthefirm'sinvestors,includingbondholders.Therefore,interestpaymentstobondholdersarenotremovedfromrevenuestoderiveFCFF.FCFEisFCFFminusinterestpaymentstobondholdersplusnetborrowingsfrombondholders.(StudySession10,LOS30.a)
WhichofthefollowingistheleastlikelyreasonforCarson'sdecisiontouseFCFEinvaluingOverhaulratherthanFCFF?
Overhaul'scapitalstructureisstable.
FCFEisaneasierandmorestraightforwardcalculationthanFCFF.
Overhaul'sdebtratioissignificantlyhigherthantheindustryaverage.
Explanation
ThedifferencebetweenFCFFandFCFEisrelatedtocapitalstructureandresultinginterestexpense.Whenthecompany'scapitalstructureisrelativelystable,FCFEiseasierandmorestraightforwardtouse.FCFFisgenerallythebestchoicewhenFCFEisnegativeorthefirmishighlyleveraged.ThefactthatOverhaul'sdebtratioissignificantlyhigherthantheindustryaveragewouldargueagainsttheuseofFCFE.Hence,thisistheleastlikelyreasontofavorFCFE.(StudySession10,LOS30.a)
AssumingthatCarsonisusingMay1,2005ashisdateofvaluation,whatistheestimatedvalueofthefirm'sequityunderthescenariomostsuitedtousingthetwostageFCFEmethod?
$129.5million.
$173.3million.
$125.2million.
Explanation
The"sustainedgrowth"scenarioistheonlyscenariosuitableforusingthetwostagemethod,inpartbecausethe"highgrowth"scenariousesthreedifferentrequiredratesofreturn.
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Question#30of145 QuestionID:463303
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C)
First,weneedtocalculateestimatedFCFEin2006.SincetherewerenosalesofPPE,wecancalculateFCInvasthechangeinGrossPPE.
FCFE=NI+NCCFCInvWCInv+NetBorrowing=16.9+80(480400)[(5570)(5050)]+(113.1140)=16.9+8080+1526.9=$5millionin2006
HavingcalculatedFCFEin2006,wecancalculateFCFEfor2007through2011usingthegrowthratesprovided:
2007 2008 2009 2010 2011
GrowthinFCFE 40.0% 15.7% 8.6% 9.1% 8.3%
Impliedlevelof
FCFE
(inmillions)
$7.0 $8.1 $8.8 $9.6 $10.4
NowthatweknowFCFE,wecandiscountfutureFCFEbacktothepresentatthecostofequity.
Inthefirststageofthetwostagemodel,wedeterminetheterminalvalueatthestartoftheconstantgrowthperiodasfollows:
TerminalValue=(10.41.06)/(0.120.06)=$183.733million.
Inthesecondstage,wediscountFCFEforthefirstsixyearsandtheterminalvaluetothepresent.
EquityValue=[5.0/(1.12) ]+[7.0/(1.12) ]+[8.1/(1.12) ]+[8.8/(1.12) ]+[9.6/(1.12) ]+[(10.4+183.7333)/(1.12) ]EquityValue=4.46+5.58+5.77+5.59+5.45+98.35EquityValue=$125.20million
(StudySession12,LOS36.j)
WhatistheexpectedgrowthrateinFCFFthatCarsonmusthaveusedtogeneratehisvaluationof$1.08billion?
5%.
7%.
12%.
Explanation
SinceFirmValue=FCFF /(WACCg),wefirstneedtodetermineFCFF ,whichisFCFFin2006:FCFF=NI+NCC+[Int(1taxrate)]FCInvWCInv=16.9+80+[34(10.35)](480400)[(5570)(5050)]=16.9+80+22.180(15)=54FirmValue=FCFF /(WACCg)1080=54/(0.12x)[(1080)(0.12)]1080x=54129.61080x=5475.6=1080x0.07=x
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Question#31of145 QuestionID:463304
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Question#32of145 QuestionID:463305
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TheexpectedgrowthrateinFCFFthatCarsonmusthaveusedis7%.(StudySession12,LOS36.j)
IfCarsonhadestimatedFCFEundertheassumptionthatOverhaulTruckingmaintainsatargetdebttoassetratioof36percentfornewinvestmentsinfixedandworkingcapital,whatwouldbehisforecastof2006FCFE?
$9.6million.
$26.5million.
$16.9million.
Explanation
FCFE=NI[(1DR)(FCInvDep)][(1DR)WCInv]
Where:DR=targetdebttoassetratioFCFE=16.9[(10.36)(48040080)][(10.36)((5570)(5050))]=16.9(0.640)(0.64(15))=16.9+0+9.6=26.5
(StudySession12,LOS36.j)
RegardingthestatementsmadebyCarsonandEckhardtaboutthevalueofOverhaulinthehighgrowthscenario:
botharecorrect.
onlyoneiscorrect.
bothareincorrect.
Explanation
Thisisacomplexproblem.Itwouldhelptocreateatable:
2006(year1)
2007(year2)
2008(year3)
2009(year4)
2010(year5)
2011(year6)
2012(year7)
GrowthinFCFE(given) n/a 30% 30% 30% 21% 12% 3%ForecastFCFE(calculated) 5.0 6.50 8.45 10.99 13.29 14.89 15.33Requiredreturntoequity(given) 20% 20% 20% 20% 15% 15% 15%
Totaldiscountfactor(calculated) 1.20 (1.20) (1.20) (1.20) (1.20) (1.15) (1.20) (1.15) (1.20) (1.15)
PVofFCFE 4.17 4.51 4.89 5.30 5.57 5.43 4.86
WebeginwiththeforecastgrowthratesinFCFEinline1.SincewehavepreviouslycalculatedthatFCFEis$5millionin2006,wecanusethegrowthratesfromline1toforecastFCFEineachyearonline2.
Line3,requiredreturntoequity,isgiven.Usingthat,wecancalculatediscountfactorsinline4.
Noticethatthetotaldiscountfactorissimplyeachyear'sfactormultipliedtogether.Forexample,thetotaldiscountfactorforyear4is(1.20) sothetotaldiscountfactorforyear5,whentheyear5requiredrateofreturndropsfrom20%to15%,becomes(1.20) (1.15).
Usingthetotaldiscountfactorsfromline4,wecancalculatethepresentvalueofeachyear'scashflowinline5.Forexample,thepresentvalueofyear2010FCFEof$13.29millionwillbe$13.29/[(1.20) (1.15)]or$5.57million.
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4
4
4
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Question#33of145 QuestionID:463190
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Question#34of145 QuestionID:463307
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B)
Oncewehavethediscountedcashflowsforeachyear,weneedtocalculatetheterminalvalue.Terminalvaluewillbe:
TV=(15.33)(1.03)/(0.100.03)
TV=15.7899/0.07
TV=$225.57million
Notethattherequiredrateofreturnusedfortheterminalvalueistherateforthesteadygrowthperiod,whichislowerthanthatusedinthehighgrowthphase(stage)orthedeclininggrowthphase(stagetwo).
Wenowneedtodiscountterminalvaluebackusingthetotaldiscountfactorfor2012:
PVofterminalvalue=$225.57million/[(1.20) (1.15) ]
PVofterminalvalue=$71.53million
Addingtogetherthediscountedcashflowsforeachyearwiththediscountedterminalvalue,wehave:
Equityvalue=4.17+4.51+4.89+5.30+5.57+5.43+4.86+71.53=$106.26million
Sincetheequityvalueofthefirmis$106.26million,Burcarshouldbewillingtopayupto$106.260.15=$15.94millionfora15%stakeinthefirm.Sincethisisslightlylessthan$16million,Carson'sstatementiscorrect.Theterminalvaluerepresents($71.53/$106.26)=67.3%ofthefirm'spresentvalue,soEckhardt'sstatementisalsocorrect.(StudySession12,LOS36.j)
Incomputingfreecashflow,themostsignificantnoncashexpenseisusually:
depreciation.
capitalexpenditures.
deferredtaxes.
Explanation
Depreciationisusuallythelargestnoncashexpense.
Afirmhas:
Freecashflowtothefirm=$4.0million.
Weightedaveragecostofcapital=10%.
Totaldebt=$30.0million.
Longtermexpectedgrowthrate=5%.
Valueofthefirm=$50.00pershare.
Whatwillhappentothevalueofthefirmiftheweightedaveragecostofcapitalincreasesto12%?
Thevaluewillremainthesame.
Thevaluewillincrease.
4 3
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Question#35of145 QuestionID:463310
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Question#36of145 QuestionID:463202
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Question#37of145 QuestionID:463311
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C)
Thevaluewilldecrease.
Explanation
Everythingelsebeingconstant,anincreaseintherelevantrequiredrateofreturnshoulddecreasethevalueofthefirm.
Infiveyears,afirmisexpectedtobeoperatinginastageofitslifecyclewhereinitsexpectedgrowthrateis5%,indefinitelyitsrequired
rateofreturnonequityis11%itsweightedaveragecostofcapitalis9%andthefreecashflowtoequityinyear6willbe$5.25per
share.Whatisitsprojectedterminalvalueattheendofyear5?
$131.25.
$51.93.
$87.50.
Explanation
Terminalvalue=FCFE/(kg)=$5.25/(0.110.05)=$87.50
Inforecastingfreecashflowsitiscommontoassumethatinvestmentinworkingcapital:
isgreaterthanfixedcapitalinvestmentduringagrowthphase.
willbefinancedusingthetargetdebtratio.
willequalfixedcapitalinvestment.
Explanation
Itisusuallyassumedthattheinvestmentinworkingcapitalwillbefinancedconsistentwiththetargetdebtratio.
Terminalvalueinmultistagefreecashflowvaluationmodelsisoftencalculatedasthepresentvalueof:
atwostagevaluationmodel'sprice.
freecashflowdividedbythegrowthrate.
aconstantgrowthmodel'spriceasofthebeginningofthelaststage.
Explanation
Terminalvaluesareusuallycalculatedasthepresentvalueofthepriceproducedbyaconstantgrowthmodelasofthebeginningofthe
laststage.
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Questions#3843of145
Question#38of145 QuestionID:463260
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Question#39of145 QuestionID:463261
ThefollowinginformationwascollectedfromthefinancialstatementsofBankersIndustrialCorp(BIC)fortheyearendedDecember31,
2013.
Earningsbeforeinterestandtaxes(EBIT)=$6.00million.
Capitalexpenditures=$1.25million.
Depreciationexpense=$0.63million.
Workingcapitaladditions=$0.59million.
Costofdebt=10.50%.
Costofequity=16.00%.
StablegrowthrateforFCFF=7.00%.
StablegrowthrateforFCFE=10.00%.
Marketvalueofdebt=$20.00million.
Bookvalueofdebt=$22.50million.
Outstandingshares=500,000.
Interestexpense=$2.00million.
NewDebtborrowing=$3.30million.
Debtrepayment=$2.85million.
GrowthratesfortwostagegrowthmodelforFCFE:
25.0%forYears13.
6.0%forYears4andthereafter.
BICiscurrentlyoperatingattheirtargetdebtratioof40.00%.Thefirm'staxrateis40.00%.
Thefreecashflowtothefirm(FCFF)forthecurrentyearisclosestto:
$3.57million.
$2.39million.
$2.31million.
Explanation
TheFCFFforthecurrentyearis[$6.00m(10.40)]+$0.63m$1.25m$0.59m=$2.39m.
(LOS36.d)
TheappropriatediscountratetoapplyinvaluingBICusingFCFFisclosestto:
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Question#40of145 QuestionID:463262
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Question#41of145 QuestionID:463263
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Question#42of145 QuestionID:463264
12.1%.
16.0%.
13.8%.
Explanation
Theappropriatediscountratetouseistheweightedaveragecostofcapital(WACC),andthisisWACC=(0.600.16)+[0.400.105
(10.40)]=12.12%.
(LOS36.j)
Theestimatedvalueofthefirmisclosestto:
$38million.
$47million.
$50million.
Explanation
ThevalueofBICusingastablegrowthFCFFmodelis$49.95million,calculatedas:
FCFF=[$6.00m(10.40)]+$0.63m$1.25m$0.59m.=$2.39m
WACC=(0.600.16)+[0.400.105(10.40)]=12.12%.
Estimatedvalue=($2.39m1.07)/(0.12120.07)=$49.95million.
(LOS36.j)
Iftheestimatedvalueofthefirmis$50.0million,thevaluepershareofBICstockshouldbeclosestto:
$60.
$28.
$30.
Explanation
Equityvalue=Firmvaluemarketvalueofdebt$50million$20million=$30million:
$30,000,000/500,000=$60.00pershare.
(LOS36.j)
Iftheestimatedvalueofthefreecashtothefirm(FCFF)foryear0is$2.4million,thevaluepershareofBICstock,basedonthestablegrowthmodel,isclosestto:
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Question#43of145 QuestionID:463265
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Question#44of145 QuestionID:463174
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B)
C)
$61
$55
$39
Explanation
FCFE=FCFFInterestexpense(1taxrate)+Netborrowing=$2.40million[$2.00million(10.40)]+$3.30million$2.85million=$1.65million.
Thevalueofequityis:[$1.65million(1+0.10)]/(0.160.10)=$30.25million.
Onapersharebasis:$30.25million/500,000=$60.50
(LOS36.j)
ThecurrentmarketpriceofBICis$62.50pershare,andthecurrentyear'sFCFEis$1.75million.Usingatwostagegrowthmodeltofindtheestimatedthefirm'svalue,thecurrentmarketpriceBICismostaccuratelydescribedas:
overvalued.
fairlyvalued.
undervalued.
Explanation
FCFE=FCFFInterestexpense(1T)+Newborrowing.
Year 0 1 2 3 4Growthrate 25.0% 25.0% 25.0% 6.0%FCFEinmil$
$1.750 $2.188 $2.734 $3.418 $3.623
Theterminalvalueis$3,623/(0.160.06)=$36,230million.Thecalculatorinputs:CF0=0,CF1=$2,188,CF2=$2,734,CF3=$3,418+$36,230=$39,648,I=16,NPV=$29.319million.
Persharepriceis$29,319,000/500,000=$58.64.Thestockappearstobeovervaluedatthecurrentmarketpriceof$62.50pershare,asourestimatedvalueof$58.64suggeststhatthemarketpriceistoohigh.
(LOS36.m)
Thedifferencebetweenfreecashflowtoequity(FCFE)andfreecashflowtothefirm(FCFF)is:
beforetaxinterestandnetborrowing.
earningsbeforeinterestandtaxes(EBIT)lesstaxes.
aftertaxinterestandnetborrowing.
Explanation
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Question#45of145 QuestionID:463222
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Question#46of145 QuestionID:463230
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Question#47of145 QuestionID:463258
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C)
FCFE=FCFF[interestexpense](1taxrate)+netborrowing.
Therepurchaseof20%ofafirm'soutstandingcommonshareswillcausefreecashflowtothefirm(FCFF)to:
decrease.
remainthesame.
increase.
Explanation
Sharerepurchasesareauseoffreecashflows,notasource.FCFFiscashflowthatisavailabletoallcapitalsuppliers.Noticethe
conspicuousabsenceofrepurchasesinthefollowing:FCFF=CFO+Int(1taxrate)FCInv.
Whichofthefollowingfreecashflowtothefirm(FCFF)modelsismostsuitedtoanalyzefirmsthataregrowingatafasterratethanthe
overalleconomy?
HighgrowthFCFFmodel.
NogrowthFCFFmodel.
TwostageFCFFmodel.
Explanation
ThetwostageFCFFmodelismostsuitedforanalyzingfirmsgrowingataratefasterthantheoveralleconomy.Thetwostagemodel
assumesahighrateofgrowthforaninitialperiod,followedbyanimmediatejumptoaconstant,stablegrowthrate.
ThevalueofstockunderthetwostageFCFEmodelwillbeequalto:
presentvalue(PV)ofFCFEduringtheextraordinarygrowthandtransitionalperiodsplusthePVofterminalvalue.
presentvalue(PV)ofFCFEduringtheextraordinarygrowthperiodplustheterminalvalue.
presentvalue(PV)ofFCFEduringtheextraordinarygrowthperiodplusthePVofterminalvalue.
Explanation
ThevalueofstockunderthetwostageFCFEmodelwillbeequaltothepresentvalueofFCFEduringtheextraordinarygrowthperiodplusthepresentvalueoftheterminalvalueattheendofthisperiod.
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Question#48of145 QuestionID:463308
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Question#49of145 QuestionID:463236
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Question#50of145 QuestionID:463193
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B)
C)
Afirmhas:
Freecashflowtoequity=$4.0million.
Costofequity=12%.
Longtermexpectedgrowthrate=5%.
Valueofequitypershare=$57.14pershare.
Whatwillhappentothevalueofthefirmiffreecashflowtoequitydecreasesto$3.2million?
Thereisinsufficientinformationtotell.
Thevaluewilldecrease.
Thevaluewillincrease.
Explanation
Everythingelsebeingconstant,adecreaseinfreecashflowtoequityshoulddecreasethevalueofthefirm.
Whichofthefollowingfreecashflowtoequity(FCFE)modelsismostsuitedtoanalyzefirmsinanindustrywithsignificantbarriersto
entry?
StableGrowthFCFEModel.
TwostageFCFEModel.
FCFEPerpetuityModel.
Explanation
ThetwostageFCFEmodelismostsuitedforanalyzingfirmsinhighgrowththatwillmaintainthatgrowthforaspecificperiod,suchas
firmswithpatentsorfirmsinanindustrywithsignificantbarrierstoentry.
WhichofthefollowingitemsisNOTsubtractedfromthenetincometocalculatefreecashflowtoequity(FCFE)?
increaseinaccountsreceivable.
Interestpaymentstobondholders.
Increaseinfixedassets.
Explanation
Interestpaymentstobondholdersareincludedintheincomestatementandarealreadysubtractedtocalculatenetincome.
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Question#51of145 QuestionID:463200
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Question#52of145 QuestionID:463277
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Question#53of145 QuestionID:463309
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Onapersharebasisforafirm:
Salesare$10.00.
Earningspershare(EPS)is$4.00.
Depreciationis$3.00.
Aftertaxinterestis$2.40.
Investmentinworkingcapitalis$1.50.
Investmentinfixedcapitalis$2.00.
Whatisthefirm'sexpectedfreecashflowtothefirm(FCFF)pershare?
$5.90.
$7.50.
$2.90.
Explanation
FCFF=EPS+netnoncashcharges+aftertaxinterestFCInvWCInvFCFF=$4.00+3.00+$2.40$2.001.50=$5.90
Afirm'sfreecashflowtoequity(FCFE)inthemostrecentyearis$50Mandisexpectedtogrowat5%peryearforever.Ifits
shareholdersrequireareturnof12%,thevalueofthefirm'sequityusingthesinglestageFCFEmodelis:
$714M.
$417M.
$750M.
Explanation
Thevalueofthefirm'sequityis:$50M1.05/(0.120.05)=$750M
InthetwostageFCFEmodel,therequiredrateofreturnforcalculatingterminalvalueshouldbe:
lowerthantherequiredrateofreturnusedforthehighgrowthphase.
higherthantherequiredrateofreturnusedforthehighgrowthphase.
equaltotheaveragerequiredrateofreturnfortheindustry.
Explanation
Inmostcases,therequiredrateofreturnusedtocalculatetheterminalvalueshouldbelowerthantherequiredrateofreturnusedforinitialhighgrowthphase.Duringthestableperiodthefirmislessriskyandtherequiredrateofreturnisthereforelower.
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Questions#5459of145
Question#54of145 QuestionID:463286
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BeachwoodBuildersmergedwithCountryPointHomesinDecember31,1992.Bothcompanieswerebuildersofmidscaleandluxuryhomesintheirrespectivemarkets.In2004,becauseoftaxconsiderationsandtheneedtosegmentthebusinessesbetweenmidscaleandluxuryhomes,BeachwooddecidedtospinoffCountryPoint,itsluxuryhomesubsidiary,toitscommonshareholders.BeachwoodretainedBernheimSecuritiestovaluethespinoffofCountryPointasofDecember31,2004.
Whenthebooksclosedon2004,Beachwoodhad$140millionindebtoutstandingduein2012atacouponrateof8%,aspreadof2%abovethecurrentriskfreerate.Beachwoodalsohad5millioncommonsharesoutstanding.Itpaysnodividends,hasnopreferredshareholders,andfacesataxrateof30%.Whenvaluingcommonstock,Bernhiem'svaluationmodelsutilizeamarketriskpremiumof11%.
ThecommonequityallocatedtoCountryPointforthespinoffwas$55.6millionasofDecember31,2004.TherewasnolongtermdebtallocatedfromBeachwood.
TheManagingDirectorinchargeofBernheim'sconstructiongroup,DenzelJohnson,ispreppingforthevaluationpresentationforBeachwood'sboardwithCaraNguyen,oneofthefirm'sassociates.NguyentellsJohnsonthatBernheimestimatedCountryPoint'snetincomeat$10millionin2004,growing$5millionperyearthrough2008.BasedonNguyen'scalculations,CountryPointwillbeworth$223.7millionin2008.NguyendecidedtouseacostofequityforCountryPointinthevaluationequaltoitsreturnonequityattheendof2004(roundedtothenearestpercentagepoint).
NguyenalsogivesJohnsonthetablesheobtainedfromBeachwoodprojectingdepreciation(theonlynoncashcharge)andcapitalexpenditures:
$(inmillions) 2004 2005 2006 2007 2008
Depreciation 5 6 5 6 5
CapitalExpenditures 7 8 9 10 12
Lookingatthenumbers,JohnsontellsNguyen,"CountryPoint'sfreecashflow(FCF)willbe$25millionin2006."Nguyenadds,"That'sFCFtotheFirm(FCFF).FCFtoEquity(FCFE)willbelower."
RegardingthestatementsbyJohnsonandNguyenaboutFCFin2006:
onlyNguyenisincorrect.
bothareincorrect.
onlyJohnsonisincorrect.
Explanation
ToestimateFCF,wecanconstructthefollowingtableusingthetablegivenandtheinformationaboutgrowthinnetincome:
$(inmillions) 2004 2005 2006 2007 2008
NetIncome 10 15 20 25 30
Plus:Depreciation 5 6 5 6 5
Less:CapitalExpenditures 7 8 9 10 12
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Question#55of145 QuestionID:463287
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Question#56of145 QuestionID:463288
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B)
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Question#57of145 QuestionID:463289
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C)
FreeCashFlow 8 13 16 21 23
Theestimatedfreecashflowfor2006is$16million.Johnson'sstatementisincorrect.SincenoneofBeachwood'sdebtisallocatedtoCountryPoint,allthefinancingisintheformofequity,soFCFFandFCFEareequal.Nguyen'sstatementisalsoincorrect.(StudySession12,LOS36.j)
IfFCInvequalsFixedCapitalInvestmentandWCInvequalsWorkingCapitalInvestment,whichstatementaboutFCFanditscomponentsisleastaccurate?
WCInvisthechangeintheworkingcapitalaccounts,excludingcashandshorttermborrowings.
FCFF=(EBITDA(1taxrate))+(Depreciationtaxrate)FCInvWCInv.
FCFE=(EBIT(1taxrate))+DepreciationFCInvWCInv.
Explanation
Thecorrectversionofthisequationis:FCFF=(EBIT(1taxrate))+DepreciationFCInvWCInv(StudySession12,LOS36.j)
WhatisthecostofcapitalthatNguyenusedforhervaluationofCountryPoint?
17%.
15%.
18%.
Explanation
SincethereisnodebtallocatedtoCountryPoint,thecostofcapitalwillequalthecostofequity.NguyensaidthatsheusedacostofequityequaltoCountryPoint'sReturnonEquity(ROE)atyearend,roundedtothenearestpercentagepoint.Sincethenetincomeattheendof2004was$10millionandtheallocatedcommonequitywas$55.6million,thereturnofequityis(10million/55.6million)=18%.(StudySession18,LOS62.c)
GivenNguyen'sestimateofCountryPoint'sterminalvaluein2008,whatisthegrowthassumptionshemusthaveusedforfreecashflowafter2008?
3%.
7%.
9%.
Explanation
Weknowtheterminalvaluein2008is$223.7million.Wecancalculatethefreecashflowin2008tobe$23million(=$30millionnetincome+$5milliondepreciation$12millioncapitalexpenditures).(Seethetableinquestion1).Thus,wecansolvefortheestimatedgrowthrate:
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Question#58of145 QuestionID:463290
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Question#59of145 QuestionID:463291
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B)
C)
Terminalvalue=[CF@2008(growthrate+1)]/(discountrategrowthrate)
223.7million=($23million(growthrate+1))/(0.18growthrate)
223.7million(0.18growthrate)=23million(growthrate+1)
40.266(223.7growthrate)=23million+(23growthrate)
17.266=246.7(growthrate)
growthrate=0.07
Nguyen'sgrowthrateassumptionis7%peryear.(StudySession12,LOS36.c)
ThevalueofbetaforCountryPointis:
1.09.
1.00.
1.27.
Explanation
Theriskfreerateis(8%2%)=6%.Wearetoldthatthemarketriskpremiumis11%,andwecalculatedthecostofequity(requiredreturn)tobe(10million/55.6million=)18%.Sinceweknowtheriskfreerate,themarketriskpremium,andthediscountrate,wecanusethecapitalassetpricingmodeltosolveforbeta:
Requiredrateofreturn=0.18=0.06+(b0.11)
0.180.06=b0.11
0.12=b0.11
b=1.09
(StudySession12,LOS36.c)
WhatistheestimatedvalueofCountryPointinaproposedspinoff?
$162.6million.
$178.3million.
$144.5million.
Explanation
Usingthediscountedcashflowapproachonthelevelsofcashflowwecalculated(seethetableinquestion1):
Firmvalue=($13/1.18 )+($16/1.18 )+($21/1.18 )+($23/1.18 )+($223.7/1.18 )
=$11.0+$11.5+$12.8+$11.9+$115.4
=$162.6million
(StudySession12,LOS36.c)
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Question#60of145 QuestionID:463212
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Question#61of145 QuestionID:463256
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Question#62of145 QuestionID:463267
Thedifferencebetweenthevalueestimateproducedbythedividenddiscountmodel(DDM)andtheoneproducedbythefreecashflowto
equity(FCFE)modelcanbeaccountedforbywhichofthefollowing?
Differentsalesforecast.
Thevalueincontrollingthefirm'sdividendpolicy.
Differentestimatesofmodelrisk.
Explanation
ThedifferencebetweenthevalueestimateproducedbytheDDMandtheoneproducedbytheFCFEmodelcanbeinterpretedasthe
valueofcontrollingthefirm'sdividendpolicy.
Afirm'sfreecashflowtothefirm(FCFF)inthemostrecentyearis$80Mandisexpectedtogrowat3%peryearforever.Ifthefirmhas
$100Mindebtfinancinganditsweightedaveragecostofcapitalis10%.Thevalueofthefirm'sequityusingthesinglestageFCFFmodel
is:
$1,177M.
$1,043M.
$1,077M.
Explanation
Thevalueofthefirm'sequityisequaltothevalueofthefirmminusthevalueofthedebt.Firmvalue=$80M1.03/(0.100.03)=
$1,177M,soequityvalueis$1,177M$100M=$1,077M.
AnanalysthaspreparedthefollowingscenariosforSchneider,Inc.:
Scenario1Assumptions
TaxRateis40%.
Weightedaveragecostofcapital(WACC)=12%.
Constantgrowthrateinfreecashflow=3%.
Lastyear,freecashflowtothefirm(FCFF)=$30.
Targetdebtratio=10%.
Scenario2Assumptions
TaxRateis40%.
Expensesbeforeinterestandtaxes(EBIT),capitalexpenditures,anddepreciationwillgrowat15%forthenextthreeyears.
Afterthreeyears,thegrowthinEBITwillbe2%,andcapitalexpenditureanddepreciationwilloffseteachother.
Weightedaveragecostofcapital(WACC)duringhighgrowthstage=20%.
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Question#63of145 QuestionID:463237
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Questions#6469of145
Weightedaveragecostofcapital(WACC)duringstablegrowthstage=12%.
Targetdebtratio=10%.
Scenario2FCFFYear0
(lastyear)Year1 Year2 Year3 Year4
EBIT $15.00 $17.25 $19.84 $22.81 $23.27
CapitalExpenditures 6.00 6.90 7.94 9.13
Depreciation 4.00 4.60 5.29 6.08
ChangeinWorkingCapital 2.00 2.10 2.20 2.40 2.40
FCFF 5.95 7.06 8.25 11.56
GiventheassumptionscontainedinScenario2,whatisthevalueofthefirm?
$81.54.
$96.92.
$70.39.
Explanation
UsethetwostageFCFFmodeltovaluethefirm.TheTerminalValueofthefirmasofYear3=11.56/(0.120.02)=115.60.Thevalue=
5.95/(1.20)+7.06/(1.20) +(8.25+115.62)/(1.20) =81.54.
WhichofthefollowingstatementsregardingtheFCFFmodelsismostaccurate?ThetwostageFCFFmodelismoreusefulthanthe
stablegrowthFCFFmodelwhenthefirmisgrowingatarate:
significantlyhigherthanthatoftheoveralleconomy.
notsignificantlyhigherthanthatoftheoveralleconomy.
significantlylowerthanthatoftheoveralleconomy.
Explanation
ThetwostageFCFFmodelismoreusefulinvaluingafirmthatisgrowingataratesignificantlyhigherthantheoveralleconomy.Since
thiscannotpersistindefinitely,growthwilleventuallyslowtoastablegrowthrateconsistentwiththatoftheeconomy.
ThefollowinginformationwascollectedfromthefinancialstatementsofHillerGmbH,aGermanconsultingcompany,fortheyearending
December31,2013:
Earningspershare=4.50.
CapitalExpenditurespershare=3.00.
Depreciationpershare=2.75.
Increaseinworkingcapitalpershare=0.75.
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Question#66of145 QuestionID:463208
Debtfinancingratio=30.0%.
Costofequity=12.0%.
Costofdebt=6.0%.
Taxrate=30.0%.
Outstandingshares=100million.
Newdebtborrowing=15.0million.
Debtrepayment=30.0million.
Interestexpense=7.1million.
Thefinancialleverageforthefirmisexpectedtobestable.HillerusesIFRSaccountingstandardsandrecordsinterestexpenseascash
flowfromfinancing(CFF).
TwoanalystsarevaluingHillerstockbotharebasingtheiranalysisonFCFEapproaches.
Analyst#1remarks:"Hillerisarelativelymaturecompanyaconstantgrowthmodelisthebetterapproach."
Analyst#1estimatesFCFEbasedontheinformationaboveandagrowthrateof5.0%.
Analyst#2states:"Hillerjustacquiredarivalthatshouldchangetheirgrowthpattern.Ithinkathreestagegrowthmodelbasedon
industrygrowthpatternsshouldbeused."
Analyst#2estimatesFCFEpershareas3.85.Growthrateestimatesarelistedbelow,andfromyear7andthereaftertheestimated
growthrateis3.0%.
Year1 Year2 Year3 Year4 Year5 Year6 Year7+
Growthrates 12.5% 12.5% 12.5% 8.0% 6.5% 5.0% 3.0%
TheFCFEbasedonAnalyst#1'sestimatesforthebaseyearisclosestto:
3.80.
3.00.
4.85.
Explanation
BaseyearFCFE=EPS(capitalexpendituresdepreciation)(1debtratio)increaseinworkingcapital(1debtratio)=4.50
(3.002.75)(10.30)0.75(10.30)=3.80.(LOS36.d)
UsingthestablegrowthFCFEmodelassuggestedbyAnalyst#1,thevalueofHillerstockisclosestto:
51.58.
54.29.
57.00.
Explanation
Valuepershare=(3.801.05)/(0.120.05)=57.00.(LOS36.j)
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Question#69of145 QuestionID:463211
BasedonAnalyst#2'sestimates,thesumoftheterminalvalueplustheFCFEforyear6isclosestto:
82.40.
60.70.
75.80.
Explanation
EstimatesforthefutureFCFEbasedonsuppliedgrowthratesare:
Year 0 1 2 3 4 5 6 7
Growthrate 12.5% 12.5% 12.5% 8.0% 6.5% 5.0% 3.0%
FCFE/share 3.850 4.331 4.873 5.482 5.893 6.335 6.620 6.818
Terminalvalueyear6=6.818/(12.0%3.0%)=75.76
Thenominalcashflowforyear6is75.76+6.62=82.38,whichistheterminalcashflowplustheFCFEvaluefortheyear.(LOS36.e)
BasedonAnalyst#2'sestimates,thevalueofHillerstockisclosestto:
59.70.
57.00.
60.70.
Explanation
Year 0 1 2 3 4 5 6 7
Growthrate 12.5% 12.5% 12.5% 8.0% 6.5% 5.0% 3.0%
FCFE/share 3.850 4.331 4.873 5.482 5.893 6.335 6.620 6.818
Terminalvalueyear6=6.818/(12.0%3.0%)=75.76
ForthecalculatorfindNPV:CF0=0,CF1=4.33,CF2=4.87,CF3=5.48,CF4=5.89,CF5=6.34,CF6=82.38,I/Y=12.Theresultis
60.73.(LOS36.e)
TheappropriatediscountrateforvaluingHilleronafreecashflowbasisisclosestto:
12.00%.
6.54%.
9.66%.
Explanation
Theappropriatediscountrateistheweightedaveragecostofcapital.Theformulais:WACC=w r (1taxrate)+w r =(0.30)
(0.06)(10.30)+(0.70)(0.12)=0.0966or9.66%.(LOS36.j)
IfHiller'stotalfreecashflowtoequityis380millionandthegrowthrateofthefirmis3.5%,thevalueofHiller(Firm)usingthestable
d d e e
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Question#71of145 QuestionID:463257
growthmodelisclosestto:
6.7billion.
8.9billion.
4.8billion.
Explanation
FCFF=FCFENetborrowing+interestexpense(1taxrate).
FCFF=380million+(7.1million(10.3))(15million)=399.7million.
Theweightedaveragecostofcapitalis:(0.30)(0.06)(10.30)+(0.70)(0.12)=0.0966or9.66%.
Thevalueofthefirmisthen:[399.7million(1+0.035)]/(0.09660.035)=6,720million.(LOS36.d)
Usingthestablegrowthfreecashflowtothefirm(FCFF)model,whatisthevalueofQualityBuildersundertheassumptionscontainedin
thetablebelow?
QualityBuilders
FreeCashFlowtotheFirm
Year0
EBIT $500
Depreciation $200
CapitalSpending $300
WorkingCapitalAdditions $30
TaxRate 40%
AssumedConstantGrowthRatein
FreeCashFlow5%
WeightedaverageCostofCapital 11%
$2,975.00.
$2,833.33.
$6,475.00.
Explanation
ThestablegrowthFCFFmodelassumesthatFCFFgrowsataconstantrateforever.FCFFinYear0isequaltoEBIT(1taxrate)+
DepreciationCapitalSpendingWorkingCapitalAdditions=500(10.4)+20030030=170.TheFirmValue=FCFF /(rg )=
170(1.05)/(0.110.05)=$2,975.1 n
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IndustrialLightcurrentlyhas:
Freecashflowtoequity=$4.0million.
Costofequity=12%.
Weightedaveragecostofcapital=10%.
Totaldebt=$30.0million.
Longtermexpectedgrowthrate=5%.
Whatisthevalueofequity?
$57,142,857.
$60,000,000.
$27,142,857.
Explanation
Thevalueofequityis[($4,000,000)(1.05)/(0.120.05)]=$60,000,000.
WhenusingthetwostageFCFEmodel,ifincreasesinworkingcapitalappeartoohightheanalystshould:
switchtoathreestagemodel.
normalizethemtobeequaltozero.
usechangesthatarebaseduponaworkingcapitalratiothatisclosertotheindustryaverage.
Explanation
Thebestsolutionistousechangesthatarebaseduponaworkingcapitalratiothatapproximatestheindustryaverage.Theproblemwill
notbeeliminatedbyswitchingtoathreestageFCFEmodel.
Acommonapproachtoforecastingfreecashflowsisto:
calculatehistoricalfreecashflowandapplyanexpectedgrowthrate.
projectearningsbeforeinterestandtaxes(EBIT)andexpectedcapitalexpenditures.
projectnetincomeandexpectedcapitalexpenditures.
Explanation
Historicalfreecashflowsareoftenusedforforecasting.
StarshahIndustriescompetesinahighgrowth,emergingtechnologysectorthatisfacingincreasingcompetitivepressures.Sofar,the
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Question#75of145 QuestionID:463270
firmhasbeenperformingwell,earning$4.55persharein2004.Investmentrequirementswerehigh,withcapitalexpendituresof$1.75per
share,depreciationexpenseof$1.05,andanetinvestmentinworkingcapitalthatyearof$1.00pershare.However,despiteStarshah's
highgrowthrateandimpressiveprofitability,Starshah'sChairman,LorenzodiStefano,hasbecomeconcernedabouttheimpactthata
slowdowninexpectedgrowthmayhaveonthefirm'svaluation.
DiStefanoaskedStarshah'sDirectorofStrategicPlanning,KeishaSimmons,tomakeapresentationtoStarshah'sboardattheendof
2004aboutthefuturegrowthofthefirm.Thenewswassobering.SimmonstoldtheboardmembersthatStarshahcouldexpecttwomore
yearsofrapidgrowth,duringwhichtimeearningspersharecouldbeexpectedtorise45%peryearwith30%annualincreasesincapital
spendinganddepreciation.Duringthishighgrowthperiod,SimmonsestimatesthattherequiredreturnonequityforStarshahwillbe25%.
Starshahconsistentlymaintainsatargetdebtratioof0.25.
Aftertheneartermspurtofhighgrowth,however,sheandhergroupexpectStarshahtomoveeventuallytoastablegrowthperiod.During
thestablegrowthperiod,freecashflowtoequity(FCFE)willriseonly5%peryearandtheannualreturntoshareholderswilldeclineto
10%.
Thestrategygroupexpectsthetransitionalperiodbetweenhighgrowthandmaturegrowthtolastfiveyears.Duringthattime,capital
expenditureswillriseonly8%peryear,withdepreciationrising13%peryear.Thegrowthinearningsshoulddropbyeightpercentage
pointsperyear,hitting5%inthefifthyear.Duringthistransition,theexpectedreturntoshareholderswillbe15%peryear.
Throughoutthehighgrowthandtransitionalgrowthperiods,SimmonsexpectsStarshahtobeabletolimitincreasesintheinvestmentin
workingcapitalto20centsperyear.Inheranalysis,theinvestmentinworkingcapitalwillpeakin2010,decliningadimeto$2.10per
sharein2011.
AfterSimmons'presentation,theboarddebatedwhattodoabouttheincipientslowdowninStarshah'sgrowth.Amajorityoftheboard
arguedinfavorofmovingtooffsetthisslowdowninorganicgrowththroughanewemphasisongrowthbyacquisition.
OnepotentialtargetisTPX.TPX'scurrentandexpectedFCFE:$425,000in2004,$500,000in2005,$600,000thefollowingyear,and
$700,000in2007.Afterthat,StarshahexpectsFCFEatTPXtogrow3%peryearindefinitely.Starshahwouldrequireareturnonits
equityinvestmentof20%peryearinthehighgrowthstageand12%peryearinthestablegrowthstage.
DiStefanoandSimmonshadasombermeetingthedayaftertheboardpresentation.Butdespitethebleaknewsaboutfutureyears,di
Stefanohadconvincedhimselfitwasworthstayingaroundthroughthehighgrowthandtransitionalperiods.HepointedouttoSimmons
that,ifSimmons'projectionswerecorrect,thevalueofStarshah'sstockwouldbeinexcessof$450persharebythetimethecompany
hitthestablegrowthphase.DiStefanowasverypleasedwithwhatthatimpliedforthevalueofhisstockoptions.
Simmonshaddonethesamecalculationsherself,butshealsorealizedthatifrequiredratesofreturnin2012rosefromtheverymodest
10%sheusedinherboardprojectionstoonly15%,thatwouldcuttheterminalvalueofStarshah'sstockin2011toonlyhalftheleveldi
Stefanowascountingon.Sheconsideredthatvaluationtoosmalltomakethewaitworthwhile.SimmonssaidnothingtodiStefano,but
plannedtolookforanotherjob.
WhichofthefollowingFCFEmodelsisbestsuitedtoanalyzingTPX?
TwostageFCFEmodel.
StablegrowthFCFEmodel.
ThreestageFCFEmodel.
Explanation
ThetwostageFCFEmodelismostsuitedtoanalyzingTPXbecausewehavespecificforecastsforthefirstseveralyearsandthena
stablegrowthpatternintotheindefinitefuture.(StudySession12,LOS36.i)
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Question#77of145 QuestionID:463272
TheFCFEforStarshahattheendofthetransitionperiodin2011isclosestto:
$21.89.
$20.62.
$23.42.
Explanation
InordertocalculateFCFEforStarshahin2011,weneedtoconstructatableofthecomponentsofcashflowforStarshah.
Wearegiventhe2004valuesfornetincome,capitalexpenditures,depreciation,andchangeinworkingcapital.Wearealsogivengrowth
ratesforeachofthethreestagesofStarshah'sgrowth:highgrowthfortwoyearsfollowedbytransitionalgrowthforfiveyears,culminating
instablegrowthforthefollowingyears.Usingtheoriginalvaluesandtheirrelatedgrowthrates,plustheformulaforFCFE(seebelow),we
canconstructthefollowingtable:
2004 2005 2006 2007 2008 2009 2010 2011
EPS 4.55 6.60 9.57 13.11 16.91 20.46 23.12 24.27
Capitalexpenditures 1.75 2.28 2.96 3.19 3.45 3.73 4.02 4.35
Depreciation 1.05 1.37 1.77 2.01 2.27 2.56 2.89 3.27
Changeinworkingcapital 1.00 1.20 1.40 1.60 1.80 2.00 2.20 2.10
FCFE 3.28 5.02 7.63 11.01 14.67 18.08 20.62 21.89
FCFE=Earningspershare(CapitalExpendituresDepreciation)(1DebtRatio)(Changeinworkingcapital(1DebtRatio))=
24.27(4.353.27)(10.25)(2.10(10.25))
=24.270.811.57=21.89
FCFE=$21.89persharein2011.
(StudySession12,LOS36.j)
RegardingdiStefano'sandSimmons'statementsabouttheterminalvalueofStarshahstockin2011:
botharecorrect.
onlySimmonsiscorrect.
onlydiStefanoiscorrect.
Explanation
Starshahhitsthestablegrowthphasein2012.Atthatpoint,
TerminalFirmValue =(FCFEinyear2012)/(requiredrateofreturn&8722growthrate)
=$21.89(1.05)/(0.100.05)=$22.98pershare/0.05
=$460pershare.DiStefano'sstatementiscorrect.
TerminalFirmValue =(FCFEinyear2012)/(requiredrateofreturn&8722growthrate)=$21.89(1.05)/(0.150.05)
=$22.98pershare/0.10=$230pershare.Simmons'statementisalsocorrect.
(StudySession12,LOS36.j)
AssumingSimmonsisrightthattherequiredreturnonStarshahequityrisesto15%in2012andbeyond,whatisthevalueofStarshah
2011
2011
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stockattheendof2004?
$63.71.
$117.49.
$111.35.
Explanation
Inordertocalculatethefirmvalue,weneedtoknowthediscountratethatappliesovereachperiod.Sincethediscountratechanges,we
cansimplifythearithmeticbyconstructingatableofdiscountfactorsusing25%foreachofthefirsttwoyearsand15%foreachofthe
followingfiveyears:
2005 2006 2007 2008 2009 2010 2011
Discountfactor 1.25 1.56 1.80 2.07 2.38 2.73 3.14
Wecanthencalculatefirmvaluein2004usingtheFCFEvalueswecalculatedinquestion1andthestockvalueintheyear2012(thatwe
calculatedinquestion3).
Starshahequityvaluein2004=(5.02/1.25)+(7.63/1.56)+(11.01/1.80)+(14.67/2.07)+(18.08/2.38)+(20.62/2.73)+(21.89/
3.14)+(230/3.14)
=4.02+4.89+6.12+7.09+7.60+7.55+6.97+73.25
=117.49
ThevalueofStarshahstockattheendof2004is$117.49pershare.(StudySession12,LOS36.j)
WhatisthemaximumamountthatStarshahwouldbewillingtopayforTPX(inmillions)?
$5.102.
$5.874.
$6.941.
Explanation
FirmValue=[500/(1.20) ]+[600/(1.20) ]+[700/(1.20) ]+[(700)(1.03)/(0.12&87220.03)/(1.20) ]=$5,874.
ThemostthatStarshahcouldpayforTPXandstillmeetitsrequiredreturntargetsis$5.874million.(StudySession12,LOS39.j)
WhichofthefollowingFCFEmodelsisbestsuitedtoanalyzingStarshahIndustries?
ThreestageFCFEmodel.
TwostageFCFEmodel.
StablegrowthFCFEmodel.
Explanation
ThethreestageFCFEmodelismostsuitedtoanalyzefirmsinhighgrowthindustriesthatwillfaceincreasingcompetitivepressuresover
time,sincethosecompetitivepressureswillleadtoagradualdeclineinthefirm'sgrowthrate(secondstage)toastablelevel(third
1 2 3 3
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Question#83of145 QuestionID:463231
stage).(StudySession12,LOS36.i)
Currently,afirmhasnooutstandingdebt.Ifthefirmwouldaddasmallamountofleveragetoitsbalancesheet,whatshouldbethe
impactonthefirm'svalue?Therewouldbe:
nochangeinfirmvalue.
adecreaseinvalueduetohigherinterestexpense.
anincreaseinvalueduetointeresttaxshields.
Explanation
Theamountoffinancialleverageusedbyafirmwillaffectitsvalue.Forsmallamountsofleverage,theadditionalbankruptcyriskwillbe
low,andwillbemorethanoffsetbytheadditionalvalueofinteresttaxshields.
Inforecastingfreecashflowsitiscommontoassumethat:
thefirmhasnononcashexpenses.
historicalandfuturefreecashflowwillbethesame.
thefirmadherestoatargetcapitalstructure.
Explanation
Atargetdebtratioisusuallyassumedtoremainconstant.Historicalcashflowsareoftenprojectedforwardwithagrowthrate.
Terminalvalueinamultistagefreecashflowtoequity(FCFE)valuationmodelisoftencalculatedasthepresentvalueof:
FCFEdividedbythetotalofrequiredrateonequityminusgrowth.
freecashflowdividedbythegrowthrate.
atwostagevaluationmodel'sprice.
Explanation
Terminalvaluesareusuallycalculatedasthepresentvalueofthepriceproducedbyaconstantgrowthmodelasofthebeginningofthe
laststage,whichisFCFE/(requiredrateonequitygrowth).
Whichofthefollowingtypesofcompaniesisthetwostagefreecashflowtoequity(FCFE)modelbestsuitedfor?Companies:
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Question#85of145 QuestionID:463176
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Question#86of145 QuestionID:463192
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inhighgrowthindustriesthatwillfaceincreasingcompetitivepressuresovertime,
leadingtoagradualdeclineingrowthtoastablelevel.
growingataratesimilartoorlessthanthenominalgrowthrateoftheeconomy.
withpatentsorfirmsinanindustrywithsignificantbarrierstoentry.
Explanation
Thetwostagemodelisbestsuitedtoanalyzingfirmsinahighgrowthphasethatwillmaintainthatgrowthforaspecificperiod,suchas
firmswithpatentsorfirmsinanindustrywithsignificantbarrierstoentry.Companiesgrowingataratesimilartoorlessthanthenominal
growthrateoftheeconomyarebestsuitedforthesinglestageFCFEModel.Companiesinhighgrowthindustriescorrespondtothethree
StageFCFEModel.
Theownershipperspectiveimplicitinthedividendvaluationapproachisof:
apreferredstockholder.
acommonstockholder.
control.
Explanation
Dividendsaremostrelevanttothestockholderswhoreceivethemandwhohavelittlecontrolovertheiramount.
WhatisthemostlikelyreasonthatyougetanextremelylowvaluefromthethreestageFCFEmodel?Capitalexpendituresare
significantly:
higherthandepreciationduringthehighgrowthphase.
higherthandepreciationinthestablegrowthphase.
lessthandepreciationduringthehighgrowthphase.
Explanation
Ifcapitalexpendituresestimatesaresignificantlyhigherthandepreciationforthestablegrowthperiod,thenthethreestageFCFEmodel
mightresultinanextremelylowvalue.Onepossiblesolutionfortheproblemistogrowthecapitalexpendituresmoreslowlythan
deprecationinthetransitionperiodtonarrowthedifference.Anotheristoassumethatcapitalexpendituresanddepreciationwilloffset
whengrowthnormalizes.
Freecashflowtothefirmisequaltocashflowfromoperationsminusfixedcapitalinvestment:
minusaftertaxinterestexpense.
minuspretaxinterestexpense.
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Question#89of145 QuestionID:463203
plusaftertaxinterestexpense.
Explanation
Freecashflowtothefirmisequaltocashflowfromoperationsminusfixedcapitalinvestmentplusaftertaxinterestexpense.
WhichofthefollowingtypesofcompanyistheEModel,athreestagefreecashflowtoequity(FCFE)Model,bestsuitedfor?
Companies:
growingataratesimilartoorlessthanthenominalgrowthrateoftheeconomy.
inhighgrowthindustriesthatwillfaceincreasingcompetitivepressuresovertime,leadingtoa
gradualdeclineingrowthtoastablelevel.
withpatentsorfirmsinanindustrywithsignificantbarrierstoentry.
Explanation
ThethreestageFCFEmodel,orEModel,ismostsuitedtoanalyzingfirmscurrentlyexperiencinghighgrowththatwillfaceincreasing
competitivepressuresovertime,leadingtoagradualdeclineingrowthtoastablelevel.Thetwostagemodelisbestsuitedtoanalyzing
firmsinahighgrowthphasethatwillmaintainthatgrowthforaspecificperiod,suchasfirmswithpatentsorfirmsinanindustrywith
significantbarrierstoentry.Companiesgrowingataratesimilartoorlessthanthenominalgrowthrateoftheeconomyarebestsuitedfor
theStableGrowthFCFEModel.Afirmthatpaysoutallofitsearningsasdividendswillhaveagrowthrateofzero(rememberg=RR
ROE)andwouldnotbevaluedusingthethreestageFCFEmodel.
Freecashflowtothefirmvaluationuseswhichdiscountrate?
Aftertaxcostofdebt.
Costofequity.
Weightedaveragecostofcapital.
Explanation
Freecashflowtothefirmvaluationusestheopportunitycostrelevanttotheoverallfirm,whichistheweightedaveragecostofcapital.
ThefollowingtableprovidesbackgroundinformationonapersharebasisforTOYInc.intheyear0:
CurrentInformation: Year0
Earnings $5.00
CapitalExpenditures $2.40
Depreciation $1.80
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Question#91of145 QuestionID:463218
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ChangeinWorkingCapital $1.70
TOYInc.'stargetdebtratiois30%andhasarequiredrateofreturnof12%.Earnings,capitalexpenditures,depreciation,andworking
capitalareallexpectedtogrowby5%ayearinthefuture.Assumethatcapitalexpendituresandworkingcapitalarefinancedatthetarget
debtratio.
Inyear0,whatisthefreecashflowtoequity(FCFE)forTOYInc.?
$4.31.
$3.39.
$2.70.
Explanation
Year0FCFE=Earningspershare(CapitalExpendituresDepreciation)(1DebtRatio)Changeinworkingcapital(1DebtRatio)=
5.00(2.401.80)(10.3)(1.7)(10.3)=3.39.
Thestablegrowthfreecashflowtoequity(FCFE)modelisbestsuitedforwhichofthefollowingtypesofcompanies?Companies:
growingataratesimilarorlessthanthenominalgrowthrateoftheeconomy.
withsignificantbarrierstoentry.
withpatentsthatwillnotexpirefor20ormoreyears.
Explanation
CompaniesgrowingataratesimilartoorlessthanthenominalgrowthrateoftheeconomyarebestsuitedfortheStableGrowthFCFE
Model.ThethreestageFCFEmodelismostsuitedtoanalyzingfirmscurrentlyexperiencinghighgrowththatwillfaceincreasing
competitivepressuresovertime,leadingtoagradualdeclineingrowthtoastablelevel.Thetwostagemodelisbestsuitedtoanalyzing
firmsinahighgrowthphasethatwillmaintainthatgrowthforaspecificperiod,suchasfirmswithpatentsorfirmsinanindustrywith
significantbarrierstoentry.
Optimalcapitalstructureisthemixofdebtandequitythatwillmaximizethevalueofthefirmandminimize:
weightedaveragecostofcapital(WACC).
weightedaveragecostofequity.
interestexpense.
Explanation
TheoptimalcapitalstructureisthemixofdebtandequitythatwillmaximizethevalueofthefirmandminimizetheWACC.
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Question#93of145 QuestionID:463195
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Question#94of145 QuestionID:463168
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InthestablegrowthFCFEmodel,anextremelylowvaluecanresultfromallofthefollowingEXCEPT:
therequiredrateofreturnistoohighforastablefirm.
theexpectedgrowthrateistoohighforastablefirm.
capitalexpendituresaretoohighrelativetodepreciation.
Explanation
Iftheexpectedgrowthrateistoohighforastablefirm,thevalueobtainedusingthestablegrowthFCFEmodelwillbeextremelyhigh.
ThefollowinginformationpertainstotheHarrisburgTireCompany(HTC)in2000.
Earnings(netincome)=$600M.
Dividends=$120M.
Interestexpense=$400M.
Taxrate=40%.
Depreciation=$500M.
Capitalspending=$800M.
Totalassets=$10B(bookvalueandmarketvalue).
Debt=$4B(bookvalueandmarketvalue).
Equity=$6B(bookvalueandmarketvalue).
Thefirm'sworkingcapitalneedsarenegligible,andtheyplantocontinuetooperateattheircurrentcapitalstructure.
Thefreecashflowtothefirmis:
$540M.
$300M.
$420M.
Explanation
Thefreecashflowtothefirmis:
FCFF=Netincome+(Interestexpense)(1T)Capitalexpenditures+Depreciation
600M+400M(10.40)800M+500M=540M
MarkWashington,CFA,usesatwostagefreecashflowtoequity(FCFE)discountmodeltovalueTexasVanLines.Hisanalysisyields
anextremelylowvalue,whichhebelievesisincorrect.Whichofthefollowingisleastlikelytobeacauseofthissuspectvaluation
estimate?
Thecostofequityestimateinthestablegrowthperiodistoohighforastablefirm.
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Question#95of145 QuestionID:463194
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Question#96of145 QuestionID:463213
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B)
C)
Earningsaretemporarilydepressedbecauseofaonetimeextraordinaryaccountingchargein
themostrecentfiscalyear.
Theforecastofworkingcapitalasapercentageofrevenuesinthestablegrowthperiodisnot
largeenoughtomaintainthelongtermsustainablegrowthrate.
Explanation
Thelargertheestimateofworkingcapitalasapercentageofrevenues,thelargertheinvestmentinnetworkingcapital,andthelowerthe
FCFEinthestableperiod.AlowstableperiodFCFEestimatewillresultinalowestimateofvaluetoday.Thesolutionistouseaworking
capitalratioclosertothelongrunindustryaverage.
Ifthecostofequityestimateinthestablegrowthperiodistoohigh,theterminalvaluewillbetoolow.Becausetheterminalvalue
typicallymakesupalargeportionofthecurrentvalue,thiswillcausethecurrentvalueestimatetobetoolow.Thesolutionistousea
costofequityestimatebasedonabetaofone.
Ifearningsaretemporarilydepressed,alltheFCFEestimateswillbelow,andthecurrentvalueestimatewillbelow.Thesolutionistouse
anestimateoflongrunnormalizedearnings.
Afirmcurrentlyhasthefollowingpersharevalues:
Cashflowfromoperations(CFO)is$49.50.
Investmentinfixedcapitalis$40.00.
Netborrowingis$7.50.
Whatisthecurrentpersharefreecashflowtoequity(FCFE)?
$97.00.
$16.50.
$17.00.
Explanation
FCFE=CFOFCInv+netborrowing=$49.50$40.00+$7.50=$17.00
TheprimarydifferencebetweenthethreestageDDMandtheFCFEmodelis:
growthrateassumptions.
costofequity.
thedefinitionofcashflows.
Explanation
Theprimarydifferencebetweenthedividenddiscountmodelsandthefreecashflowfromequitymodelsliesinthedefinitionofcash
flows.TheFCFEmodelusesresidualcashflowsaftermeetingallfinancialobligationsandinvestmentneeds.TheDDMusesastrict
definitionofcashflowstoequity,thatis,theexpecteddividendsonthestock.
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Question#97of145 QuestionID:463171
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Question#98of145 QuestionID:463172
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Question#99of145 QuestionID:463169
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Question#100of145 QuestionID:463196
Freecashflow(FCF)approachesarethebestsourceofvaluewhen:
afirmhaspreferredstock.
afirmispayingadividendthatishigherthantheindustryaverage.
FCFstrackprofitabilitycloselyovertheanalyst'sforecasthorizon.
Explanation
FCFapproachesarebestwhenthoseflowsareagoodindicationofafirm'sprofitabilityovertheanalyst'sforecasthorizon.
Freecashflowapproachesarethebestsourceofvaluewhen:
dividendsarenotpaid.
afirmhassignificantminorityinterest.
returnonassetsisfalling.
Explanation
Freecashflowapproachesarebestwhendividendsarenotpaid.Bothremainingresponseshavenothingtodowiththedecision.
IfafirmisvaluedusingFCFF,therelevantdiscountrateisthe:
aftertaxweightedaveragecostofcapital.
beforetaxweightedaveragecostofcapital.
beforetaxcostofequity.
Explanation
SincetheFCFFisthecashavailabletoalltheinvestors,theaftertaxweightedaveragecostofcapitalshouldbeusedasthediscount
rateinFCFFmodels.
Usingtheinformationbelow,valuethestockofSymphonyPublishing,Inc.usingthefreecashflowfromequity(FCFE)valuationmethod.
Requiredreturnof13.0%.
Valueattheendofyear3of13timesFCFE .
Sharesoutstanding:10.0million.
3
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Question#101of145 QuestionID:463233
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Netincomeinyear1of$10.0million,projectedtogrowat10%forthenexttwoyears.
Depreciationperyearof$3.0million.
CapitalExpendituresperyearof$2.5million.
Increaseinworkingcapitalperyearof$1.0million.
Principalrepaymentsondebtperyearof$1.5million.
ThevaluepershareofSymphonyPublishingisapproximately:
$11.21.
$112.10.
$14.10.
Explanation
Step1:Calculateeachyear'sFCFEanddiscountattherequiredreturn.
FCFE=netincome+depreciationcapitalexpendituresincreaseinworkingcapitalprincipalrepayments+newdebtissues
Year1:10.0+3.02.51.01.5=8.0,
PV=7.08=8.0/(1.13) ,orFV=8.0,I=13,PMT=0,N=1,ComputePV
Year2:10.01.10+3.02.51.01.5=9.0,
PV=7.05=9.0/(1.13) ,orFV=9.0,I=13,PMT=0,N=2,ComputePV
Year3:10.0(1.10) +3.02.51.01.5=10.10
PV=7.00=10.10/(1.13) ,orFV=10.10,I=13,PMT=0,N=3,ComputePV
Step2:CalculatePresentValueoffinalcashflowtimesFCFEmultiple.
Valueatendofyear3=FCFE3multiple=10.1013=131.30
PV=91.00=131.30/(1.13) ,orusingcalculator,N=3,FV=131.30,I=13,PMT=0,ComputePV
Step3:Calculatepersharevalue.
AddupPVofFCFEandendvalueanddividebynumberofsharesoutstanding
=(7.08+7.05+7.00+91.0)/10.0=11.21
Abiotechfirmiscurrentlyexperiencinghighgrowthandpaysnodividends.Oneoftheirproductpatentsisscheduledtoexpirein5years.
Thisfirmwouldbeagoodcandidateforwhichofthefollowingvaluationmodels?
Twostagedividenddiscountmodel(DDM).
Twostagefreecashflowtoequity(FCFE).
Singlestagefreecashflowtoequity(FCFE).
Explanation
1
2
2
3
3
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Question#102of145 QuestionID:463254
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B)
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ThetwostageFCFEmodeliswellsuitedtovalueafirmthatiscurrentlyexperiencinghighgrowthandwilllikelyseethisgrowthdroptoa
lower,morestablerateinthefuture.
BOX,Inc.,earned$4.55persharelastyear.Thefirmhadcapitalexpendituresof$1.75pershareanddepreciationexpenseof$1.05.
BOX,Inc.,hasatargetdebtratioof0.25.
HighGrowth
PeriodTransitionalPeriod StableGrowthPeriod
Duration 2Years 5Years
Earningsgrowthrate 45%
Willdecline8%peryear
to
5%inthestablegrowth
period
5%
GrowthinCapital
Expenditures30%
Increasesby8%per
year
Same$amountas
Depreciation
GrowthinDepreciation 30%Increasesby13%per
year
Same$amountas
Capital
Expenditures
ChangeinWorking
CapitalGivenBelow GivenBelow
$2.25pershareinYear
8
ShareholderRequired
Return25% 15% 10%
Yr0 Yr1 Yr2 Yr3 Yr4 Yr5 Yr6 Yr7
Earningspershare(EPS) 4.55 6.60 9.57 13.11 16.91 20.46 23.12 24.27
CapitalExpenditures 1.75 2.28 2.96 3.19 3.45 3.73 4.02 4.35
Depreciation 1.05 1.37 1.77 2.01 2.27 2.56 2.89 3.27
Changeinworkingcapital
(WC)0.90 1.10 1.40 1.60 1.80 2.00 2.20 2.10
Freecashflowtoequity
(FCFE) 7.63 11.01 14.67 18.08 20.62 21.89
WhatisthepresentvalueofBOX,Inc.?
$195.71.
$212.91.
$223.65.
Explanation
Year1FCFE=Earningspershare(CapitalExpendituresDepreciation)(1DebtRatio)(Changeinworkingcapital)(1DebtRatio)
=6.60(2.281.37)(10.25)(1.1)(10.25)=5.09.
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Question#103of145 QuestionID:463216
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Question#104of145 QuestionID:463177
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Questions#105110of145
Year8FCFE=Earningspershare(CapitalExpendituresDepreciation)(1DebtRatio)(Changeinworkingcapital)(1DebtRatio)
=24.271.050(2.25)(10.25)=23.79.
TheTerminalValue(asofYear7)=23.79/(0.100.05)=475.80.
ThevalueofBOX,Inc.,stockwouldbeequalto:5.09/1.25+7.63/1.25 +11.01/[(1.25) (1.15) ]+14.67/[(1.25) (1.15) ]+18.08/
[(1.25) (1.15) ]+20.62/[(1.25) (1.15) ]+21.89/[(1.25) (1.15) ]+475.80/[(1.25) (1.15) ]=
4.07+4.88+6.13+7.10+7.61+7.55+6.97+151.40=195.71
Dividendspaidouttotheshareholders:
arealwayslessthanfreecashflowtoequity(FCFE).
maybehigherthanfreecashflowtoequityFCFE.
arealwaysequaltofreecashflowtoequity(FCFE).
Explanation
Dividendsrepresentthecashthatthefirmchoosestopaytotheshareholdersandtheamountofthedividendissubjecttothediscretion
ofthefirm.Dividendscanbeequalto,lowerorhigherthanFCFE.Forexample,sometimesfirmsmaypaydividendsinyearswhenthere
isanetloss.
Freecashflow(FCF)approachesarethebestsourceofvaluewhen:
afirmhasnopreferredstock.
dividendsarepaidbutdonotreflectthecompany'scapacitytopaydividends.
afirmhassignificantminorityinterest.
Explanation
FCFapproachesarebestwhendividendsarepaidbutdonotappeartoberepresentativeofthefirm'scapacitytopaythem.Both
remainingresponseshavenothingtodowiththedecision.
TOY,Inc.isacompanythatmanufacturesdolls,games,andotheritemstoentertainchildren.
ThefollowingtableprovidesbackgroundinformationforTOY,Inc.onapersharebasisintheyear0:
CurrentInformation Year0
Earnings $5.00
CapitalExpenditures $2.40
Depreciation $1.80
ChangeinWorkingCapital $1.70
2 2 1 2 2
2 3 2 4 2 5 2 5
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Question#105of145 QuestionID:463314
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Question#106of145 QuestionID:463315
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Question#107of145 QuestionID:463316
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Costofequity 12.0%
Targetdebtratio 30.0%
Marketvalueofstock $56.00
Sharesoutstanding 5.0million
Interestexpense $7.2million
Cash&shortterm
investments$40.0million
Taxrate 37.5%
Earnings,capitalexpenditures,depreciation,andworkingcapitalareallexpectedtogrowby5.0%peryearinthefuture.
Inyear1,theforecastedfreecashflowtoequity(FCFE)forTOY,Inc.isclosestto:
$3.56.
$4.53.
$4.31.
Explanation
FCFEyear0=Earningspershare[(CapitalExpendituresDepreciation)(1DebtRatio)][(Changeinworkingcapital)(1Debt
Ratio)]=5.00[(2.401.80)(10.30)][(1.70)(10.30)]=3.39.
FCFEforyear1=FCFEyear0(1+growthrate)=3.39(1.05)=$3.56.
(LOS36.d)
ThevalueofTOY,Inc.'sstockgiventheaboveassumptions,isclosestto:
$50.86.
$64.71.
$61.57.
Explanation
Thevalueofthestock=FCFE /(rg )=3.56/(0.120.05)=50.86.
(LOS36.j)
ComparingthecurrentmarketvalueofTOYtoourestimateofthestock'scurrentmarketvalue,itismostlikelythatatthecurrentmarket
priceof$56.00,TOYInc.stockis:
fairlyvalued.
undervalued.
overvalued.
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Question#108of145 QuestionID:463317
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Question#109of145 QuestionID:463318
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Question#110of145 QuestionID:463319
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B)
Explanation
Ourcalculatedvalueofthestock=FCFE /(rg )=3.56/(0.120.05)=$50.86.Thecurrentmarketpriceis$56.00,becausethe
marketpriceisgreaterthantheestimatedprice,thestockisovervaluedinthemarket.
(LOS36.m)
SeniormanagementofTOYInc.isconsideringsellingthecompanytoarivalfirmthathasoffered$450million.Ifthecurrentmarketprice
representsthefairvalueofequityandTOYInc.maintainsitstargetcapitalstructure,thebidrepresentsapricethatis:
greaterthanthetotalvalueofthefirm.
lessthanthetotalvalueofthefirm.
aboutthesametotalvalueofthefirm.
Explanation
Thetotalvalueofafirmisthetotalmarketvalueofequityplusthetotalmarketvalueofdebt.Thetotalvalueofequityis$56.00per
share5,000,000shares=$280million.Equityrepresents70.0%ofthecapitalstructure.Thetotalvalueofthefirmisthus$280
million/0.70=$400million.Anofferof$450millionisapremiumof$50millionapricegreaterthanthecurrentvalueofthefirm.
(LOS36.m)
TheEV/EBITDAratioforTOYInc.isclosestto:
6.4x.
4.3x
7.1x
Explanation
Thetotalvalueofthefirmisthetotalmarketvalueofequityplusthetotalmarketvalueofdebt.Thetotalvalueofequityis$56.00per
share5,000,000shares=$280.0million.Equityrepresents70.0%ofthecapitalstructure.Thetotalvalueofthefirmis$280.0
million/0.70=$400.0million.Theenterprisevalueisthetotalvalueofthefirmminusthecashandshortterminvestments
$400.0million$40.0million=$360.0million.
Earningsbeforetaxes=$25.0million/(10.375)=$40.0million
EBITDA=$40.0million+$7.2million+$1.805.0millionshares=$56.2million.
EV/EBITDA=$360.0/$56.2=6.4x
(LOS37.n)
Oneyearlatertheenterprisevalueincreasedby5.0%whiletheEBITDAis$59.0million.IftheEV/EBITDAfortheindustryis7.0,
relativetoitspeers,TOYismostlikely:
undervalued.
overvalued.
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Question#111of145 QuestionID:463224
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Question#112of145 QuestionID:463170
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Question#113of145 QuestionID:463189
fairlyvalued.
Explanation
Thetotalvalueofthefirmisthetotalmarketvalueofequityplusthetotalmarketvalueofdebt.Thetotalvalueofequityis$56.00per
share5,000,000shares=$280.0million.Equityrepresents70.0%ofthecapitalstructure.Thetotalvalueofthefirmis$280.0
million/0.70=$400.0million.Theenterprisevalueforyear0isthetotalvalueofthefirmminusthecashandshortterminvestments
$400.0million$40.0million=$360.0million.Enterprisevalueoneyearlateris$360million(1.05)=$378.0million.
EV/EBITDA=$378.0/$59.0=6.4x.TheEV/EBITDAratioofTOYislessthantheindustryratio.TOYisundervaluedinthemarket.
(LOS37.r)
Ignoringanycostsrelatedtofinancialdistress,ifafirmincreasesitsfinancialleverage,thevalueofthefirmshould:
decreasebecausetherequiredrateofreturnondebtislowerthanthatofequity.
increasebecausetheweightedaveragecostofcapitalwillbelowerduetointeresttax
shields.
increasebecausetheFCFFwillincrease.
Explanation
Whenafirmaddsleverage,itsvaluemayincreaseduetothetaxshieldsoninterestexpenseandthegenerallylowercostofdebt.In
theory,thereisanoptimalcapitalstructure.Iftheamountofdebtemployedisgreaterthantheoptimal,thecostsassociatedwithriskof
bankruptcyorfinancialdistressbegintooutweightheadvantageofinteresttaxshields.
Valuationwithfreecashflowtoequityandfreecashflowtothefirm:
usedifferentdiscountrates.
bothusethecostofequity.
bothusetheaftertaxcostofdebt.
Explanation
Freecashflowtothefirmusestheweightedaveragecostofcapitalandfreecashflowtoequityusesthecostofequity.Thekeyisto
useadiscountratethatreflectstheopportunitycostoftheindicatedinvestorgroup.
ThefollowinginformationisderivedfromthefinancialrecordsofBrownCompanyfortheyearendedDecember31,2004:
Sales $3,400,000
CostofGoodsSold (2,100,000)
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Question#114of145 QuestionID:463320
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(COGS)
Depreciation (300,000)
InterestPaid (200,000)
GainonSaleofOld
Equipment
400,000
IncomeTaxesPaid (300,000)
NetIncome $900,000
BrownissuedbondsonJune30,2004andreceivedproceedsof$4,000,000.
Oldequipmentwithabookvalueof$2,000,000wassoldonAugust15,2004for$2,400,000cash.
BrownpurchasedlandforanewfactoryonSeptember30,2004for$3,000,000,issuinga$2,000,000noteandpayingthebalancein
cash.
Cashflowfromoperationslesscapitalexpendituresis:
$6,200,000.
$200,000.
$2,200,000.
Explanation
Brown'scashflowfromoperations(CFO)was$800,000=($900,000NetIncome+$300,000depreciation$400,000gain).
Capitalexpenditurecashflowswere$3,000,000forthefactoryand$2,400,000cashreceivedfromsaleoftheoldequipmentforanet
outflowofcashof$600,000.
$200,000=($800,000$600,000).
SudburyIndustriesexpectsFCFFinthecomingyearof400millionCanadiandollars($),andexpectsFCFFtogrowforeveratarateof3
percent.Thecompanymaintainsanallequitycapitalstructure,andSudbury'srequiredrateofreturnonequityis8percent.
SudburyIndustrieshas100millionoutstandingcommonshares.Sudbury'scommonsharesarecurrentlytradinginthemarketfor$80per
share.
UsingtheConstantGrowthFCFFValuationModel,Sudbury'sstockis:
undervalued.
overvalued.
fairlyvalued.
Explanation
Basedonafreecashflowvaluationmodel,SudburyIndustriessharesappeartobefairlyvalued.
SinceSudburyisanallequityfirm,WACCisthesameastherequiredreturnonequityof8%.
ThefirmvalueofSudburyIndustriesisthepresentvalueofFCFFdiscountedbyusingWACC.SinceFCFFshouldgrowataconstant3
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Question#115of145 QuestionID:463220
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Question#116of145 QuestionID:463241
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Question#117of145 QuestionID:463198
percentrate,theresultis:
Firmvalue=FCFF /WACCg=400million/0.080.03=400million/0.05=$8,000million
Sincethefirmhasnodebt,equityvalueisequaltothevalueofthefirm.Dividingthe$8,000millionequityvaluebythenumberof
outstandingsharesgivestheestimatedvaluepershare:
V =$8,000million/100millionshares=$80.00pershare
Whichofthefollowingisleastlikelytochangeasthefirmchangesleverage?
Freecashflowstofirm(FCFF).
Freeca