Question 1
Suppose that Boston Scientific is considering making an investment of $500 million in a new stent production technology. The Net Present Value of the project is
very positive and the Internal Rate of Return on the project is 250%. The Company’s WACC is 15%. The Board is very impressed with the 250% IRR. Based on
these numbers, should the project be accepted? Is the 250% IRR a good measure of the project’s annual percentage rate of return? If not, describe an improved
method for measuring the annual rate of return and note why it is an improvement.
Answer
10 points
Question 2
Assume that Thompson, Inc. generated free cash flow of $1,000 last year. Thomson’s weighted average cost of capital is 11%. Estimate the value of Thomson’s
equity under the following growth rate of free cash flow assumptions.
Year 1
25%
Year 2
20%
After Year 2 through Year 10
Declining linearly from 20% to 5%
Beyond Year 10
Continuing at 5% per year indefinitely
Value of Debt
$10,000
Answer
Question 3
Now we will explore seven changes. There are three multiple-choice questions for each of the following changes (each considered independently, holding
everything else constant). Choose the effect of the change on this year’s NOPAT (first question), Investment (second question), and Free Cash Flow (third
question).
1) A decrease in the operating profit margin.
Choose the effect on this year's NOPAT.
Answer
Increase
Decrease
No Effect
1 points
Question 4
1) A decrease in the operating profit margin.
Choose the effect on this year’s Net Operating Capital.
Answer
Decrease
Increase
No Effect
Question 5
1) A decrease in the operating profit margin.
Choose the effect on this year’s Free Cash Flow.
Increase
Decrease
No Effect
Question 6
2) An increase in Beta.
Choose the effect on this year’s NOPAT.
Answer
Increase
Decrease
No Effect
1 points
Question 7
2) An increase in Beta.
Choose the effect on this year’s Net Operating Capital.
Answer
Increase
Decrease
No Effect
Question 8
2) An increase in Beta.
Choose the effect on this year’s Free Cash Flow.
Answer
Increase
No Effect
Decrease
1 points
Question 9
3) An increase in accounts receivable.
Choose the effect on this year’s NOPAT.
Answer
Decrease
Increase
No Effect
1 points
Question 10
3) An increase in accounts receivable.
Choose the effect on this year’s Net Operating Capital.
Answer
Decrease
Increase
No Effect
1 points
Question 11
3) An increase in accounts receivable.
Choose the effect on this year’s Free Cash Flow.
Answer
Increase
Decrease
No Effect
1 points
Question 12
4) A decrease in plant and equipment (No depreciation impact).
Choose the effect on this year’s NOPAT.
Answer
Increase
No Effect
Decrease
1 points
Question 13
4) A decrease in plant and equipment (No depreciation impact).
Choose the effect on this year’s Net Operating Capital.
Answer
Decrease
Increase
No Effect
1 points
Question 14
4) A decrease in plant and equipment (No depreciation impact).
Choose the effect on this year’s Free Cash Flow.
Answer
Increase
No Effect
Decrease
points
Question 15
5) An increase in revenue growth without any increase in assets.
Choose the effect on this year’s NOPAT.
Answer
Decrease
No Effect
Increase
1 points
Question 16
5) An increase in revenue growth without any increase in assets.
Choose the effect on this year’s Net Operating Capital.
Answer
No Effect
Decrease
Increase
1 points
Question 17
An increase in revenue growth without any increase in assets.
Choose the effect on this year’s Free Cash Flow.
Answer
Decrease
No Effect
increase
Question 18
6) A decrease in accounts payable.
Choose the effect on this year’s NOPAT.
Answer
No Effect
Decrease
Increase
1 points
Question 19
6) A decrease in accounts payable.
Choose the effect on this year’s Net Operating Capital.
Answer
No Effect
ncrease
Decrease
points
Question 20
6) A decrease in accounts payable.
Choose the effect on this year’s Free Cash Flow.
Answer
Increase
No Effect
Decrease
1 points
Question 21
7) An increase in the tax rate.
Choose the effect on this year’s NOPAT.
Answer
Decrease
No Effect
Increase
1 points
Question 22
7) An increase in the tax rate.
Choose the effect on this year’s Net Operating Capital.
Answer
No Effect
Decrease
Increase
1 points
Question 23
7) An increase in the tax rate.
Choose the effect on this year’s Free Cash Flow.
Answer
Decrease
Increase
No Effect
1 points
Question 24
Suppose that Proctor and Gamble is considering instituting a bonus system for all of its business units. The bonus calculation will be based on growth in revenue
and growth in operating profit. Critique this bonus system and identify a problem that might arise. Suggest a performance target, other than growth in revenue
and growth in operating profit, that might alleviate this problem. Explain.
10 points
Question 25
Suppose Apple has excess cash invested in US Treasury Bonds earning 3%. They are considering acquiring a web-based telecommunications company, which is
similar to Apple’s existing business, for $20 billion. Apple’s WACC is 12%. What is the appropriate discount rate to use in evaluating the acquisition? Explain
clearly and concisely why this is the appropriate discount rate.
10 points
Question 26
Total Value: 15 Points
Consider the data in Exhibit 8 of the Pepsico, Inc.: Cost of Capital case and the following information. Assume a risk-free rate of 8.3%, a market risk premium of
7.2%, and a tax rate of 38%. Use total debt to measure debt and market value of equity to measure equity.
Part A (10 Points)
Use the pure-play method (including adjusting for financial risk), to estimate an adjusted weighted average cost of capital for the snack foods segment. Use
Goodmark Foods as the pure-play company for snack foods. Answer
10 points
Question 27
Part B (5 Points)
Why is it important for Pepsi to estimate an adjusted cost of capital for each segment?Answer
5 points
Question 28
Total Value: 25 Points
Use the information in Question 28 to answer Questions 29-32.
Exhibit 10.0 below presents a recent discounted cash flow valuation of State Street contained in an analyst's report prepared by Atlantic Equities, LLP. Review
the analysis and answer the following questions. Note that in this valuation, interest expense is deducted in determining free cash flow; hence the free cash flow
is to equity and is discounted at the cost of equity to arrive at the estimated value of equity. Assume the value of State Street's debt is $20 billion.
Exhibit 10.0 State Street Discounted Cash Flow Calculation $MM unless stated
Assumptions
Risk-free rate
4.36% 10-year Treasury
Equity risk premium
4.50% Historical equity risk premium
Beta 1.15 Adjusted daily beta
Cost of equity
9.54%
Revenue growth 06 to 08
12.50%
Revenue growth 09 to 14
6.50%
Terminal growth rate
5.5% GDP
Margin—stable @30% going forward
Estimate of 35% of cash flow to be reinvested
Year
2004
0
2005
1
2006
2
2007
3
2008
4
2009
5
2010
6
2011
7
2012
8
2013
9
Revenues
5,153
5,721
6,436
7,240
8,145
8,675
9,238
9,839
10,479
11,160
11,885
310,748
Margin
28.55%
Pre tax income 1471
Tax rate
33.20%
after tax income 983
maintnance
344
free cash flow 639
30.63%
1752
34.00%
1157
405
752
30.00%
1931
34.00%
1274
446
828
30.00%
2172
34.00%
1434
502
932
30.00%
2444
34.00%
1613
561
1048
30.00%
2602
34.00%
1718
601
1116
30.00%
2772
34.00%
1829
640
1187
30.00%
2952
34.00%
1948
682
1266
30.00%
3144
34.00%
2075
726
134
30.00%
3348
34.00%
2210
773
1436
30.00%
3566
34.00%
2353
824
1530
30.00%
93224
34.00%
61528
21535
3993
2004 DCF
23504
shares outsanding344
near term value68.25
Question 29
Part A: Use the data provided to estimate the cost of equity for State Street. Do you agree with the 9.54% figure?
5 points
Question 30
2014 terminal
10
10
Part B: Estimate the terminal value at the end of year 10. Do you agree with the $39,993 figure?
Answer
5 points
Question 31
Part C: Suppose that it is now the end of 2004 and that State Street generated $639 million of free cash flow in 2004. You expect free cash flow to grow at a
constant annual rate of 5%. The discount rate is 9.54%. Estimate the value per share of State Street's equity with these assumptions.
Answer
Reply