FSA 3321 (Moore-1)
Exam 4
Summer 2008
Exam 4 - Finance 3321 (Moore) – Summer 2008
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1. Which of the following increases free cash flows to the firm (both equity and debt)?
a. An increase in gross margins
b. An increase in inventories
c. An increase in dividends
d. A decrease in accounts payable
e. A increase in Plant, Property and Equipment
2. Consider a company with the following: Value of debt is 200 with kd of 12%. Value of
the firm is 600; ke is 18% and rf = 4% and T = 30%. The computed WACCAT would be:
a. 4%
b. 12%
c. 12.93%
d. 14.8%
e. 18%
3. AEG valuation models require which of the following discount factors?
a. WACC and the dividend growth rate
b. Cost of Debt and Cost of Equity
c. Cost of Debt and the dividend growth rate
d. Cost of Equity and negative terminal value growth rates
e. Cost of Equity and positive terminal value growth rates
4. Assume a firm will pay its first dividend in 3 years. This initial period’s dividend is forecast
to be $3.00 per share and is expected to grow at 6% per year in perpetuity. Assume
WACC = 12%; the cost of equity is 14%; the cost of debt is 8% and the risk-free rate is
5%. The best estimate the today’s share value using the discounted dividends method is:
a. $12.40
b. $19.60
c. $25.31
d. $28.86
e. $37.50
Page 1 of 10
FSA 3321 (Moore-1)
Exam 4
Summer 2008
5. The main benefit of the residual income valuation model (as compared to free cash flows
and discounted dividends) is that:
a. Dividend payments are too variable compared with price variability
b. The implied investment horizon to recover value is unrealistically short.
c. The price variability explained by residual income variability is relatively small.
d. The valuation is not as sensitive to terminal value growth rates as compared to free
cash flow and dividend valuation models.
e. Residual income is easier to predict than the other measures.
6. The present value (today) of the terminal (continuation) value cash flow that begins in 7
years is $20,000,000 assuming a WACC equal to 11%. The year 7 free cash flow
(beginning of the growing perpetuity) is $3,366,746. What is the growth rate required for
the continuation value term?
a. 1%
b. 2%
c. 3%
d. 4%
e. 5%
7. Assume the market return and risk-free rate remain unchanged. Which of the following
must be true if the firm’s Beta suddenly changes from 0.9 to 1.8?
a. The firms cost of equity increases by 50%
b. The firm’s cost of debt decreases in direct proportion to the increase in the cost of
equity because the WACC must remain constant
c. The WACC of the firm decreases
d. The market value of the equity increases
e. The share price will decrease
8. Which is correct regarding the Abnormal Earnings Growth valuation model?
a. Because the model incorporates cumulative dividend earnings, it is not appropriate
for valuing firms that don’t pay dividends.
b. A firm that, on average, has earned more than its Ke has negative AEG.
c. During periods when Residual Income is declining, AEG is positive for those periods.
d. A firm with forecast earnings growth less than Ke will increase shareholder value by
decreasing dividends.
e. During periods when Residual Income is declining, AEG is negative for those periods.
9. Assume a firm’s revenues and net income are projected to grow by 10% per year into
the foreseeable future. What terminal value growth rate is most appropriate for the free
cash flow valuation model when WACC is 11%?
a. -40%
b. -10%
c. 0%
d. 5%
e. 15%
Page 2 of 10
FSA 3321 (Moore-1)
Exam 4
Summer 2008
10. Assume a firm’s revenues and net income are projected to grow by 10% per year into the
foreseeable future. What terminal value growth rate is most appropriate for the AEG
valuation model?
a. -30%
b. 0%
c. 5%
d. 15%
e. 40%
11. Old Reliable Manufacturing Company's stock has a market price of $60 per share and the
market’s assessment of its steady state return on equity is 25% per year. If its cost of equity
capital is 10 percent and its book value is expected to grow at 5 percent per year indefinitely,
what is the current book value per share?
a. $15.00
b. $20.00
c. $28.86
d. $37.50
e. $60.00
12. You have just computed the Beta of a stock to be 2.5 and the estimate of the relevant
risk-free rate is 5%. The expected market return next period is 12% and your estimate
of Ke is 23%. What is the appropriate long-run market risk premium?
a. 7.0%
b. 7.2%
c. 7.5%
d. 8.0%
e. 9.0%
Page 3 of 10
FSA 3321 (Moore-1)
Exam 4
Summer 2008
Computation of Valuations Models Section
Use the following summary financial statement information and forecasts provided by TTU
Value-Metrics to answer the valuation questions in this section about Hi-Flyer Corp. which
has a December 31 fiscal year end.
(in thousands except per share data)
Net Income
Total Dividends Paid
Book Value of Equity
Total Liabilities
CFFO
CFFI
Dividends Per Share
Shares Outstanding (12/31/07)
Cost of Equity
Cost of Debt
WACC(bt)
Actual
Estimated Estimated
2007
2008
2009
225,000
250,000
300,000
48,000
50,000
55,000
1,500,000
1,000,000
400,000
500,000
600,000
-250,000
-300,000
-350,000
0.48
0.50
0.55
100,000
0.14
0.08
0.11
Estimated
2010
320,000
60,000
700,000
-400,000
0.60
13. Using the above forecasts, determine the intrinsic value of High Flyer shares. Use the
discounted dividends model; assume the forecast dividend payment in 2011 is $0.65
and that it will growth by 5% per year in perpetuity. The appropriate intrinsic value is:
a. $5.66
b. $6.14
c. $6.62
d. $8.49
e. $8.97
14. (Sensitivity Analysis). You know that dividend growth rates are estimated with error. In
the previous problem, the dividend growth perpetuity was assumed to be 5% per year.
What would be the impact on share price if the growth rate were assumed to be 8% (all
other information remains the same).
a. $2.44 higher
b. $2.77 higher
c. $3.61 higher
d. $7.31 higher
e. no impact
15. (Time Consistent Prices). Assume the valuation date is June 1, 2008 and that you
computed a share price in Problem 31 of $7.00 per share. What is the time consistent price
that would be compared with the observed price of $8.50.
a. $7.23
b. $7.31
c. $7.39
d. $7.47
e. $8.23
Page 4 of 10
FSA 3321 (Moore-1)
(in thousands except per share data)
Net Income
Total Dividends Paid
Book Value of Equity
Total Liabilities
CFFO
CFFI
Dividends Per Share
Shares Outstanding (12/31/07)
Cost of Equity
Cost of Debt
WACC(bt)
Exam 4
Summer 2008
Actual
Estimated Estimated Estimated
2007
2008
2009
2010
225,000
250,000
300,000
320,000
48,000
50,000
55,000
60,000
1,500,000
1,000,000
400,000
500,000
600,000
700,000
-250,000
-300,000
-350,000
-400,000
0.48
0.50
0.55
0.60
100,000
0.14
0.08
0.11
16. (Free Cash Flow Valuation). Assume that free cash flow to the firm is forecast to be
$400,000 in 2011 and that it is expected to grow by 5% per year thereafter. The
estimated intrinsic value per share is (12/31/07):
a. $44.77
b. $59.77
c. $61.27
d. $117.22
e. $54.77
17. (Residual Income). Compute the book value of equity at the beginning of 2010.
a. $1,700,000
b. $1,895,000
c. $1,945,000
d. $2,145,000
e. $2,205,000
18. (Residual Income Valuation). Compute the normal income for 2009.
a. $47,700
b. $62,000
c. $210,000
d. $238,000
e. $272,300
19. (Residual Income Valuation). Compute the intrinsic value of Hi-Flyer’s shares at the end
of 2007. Assume residual income will be $35,000 in 2011 (perpetuity start) with a growth
rate in the perpetuity of -30% per year.
a. $1.69
b. $16.69
c. $16.95
d. $31.69
e. $53.69
Page 5 of 10
FSA 3321 (Moore-1)
Exam 4
Summer 2008
(in thousands except per share data)
Actual
Estimated Estimated Estimated
2007
2008
2009
2010
Net Income
225,000
250,000
300,000
320,000
Total Dividends Paid
48,000
50,000
55,000
60,000
Book Value of Equity
1,500,000
Total Liabilities
1,000,000
CFFO
400,000
500,000
600,000
700,000
CFFI
-250,000
-300,000
-350,000
-400,000
Dividends Per Share
0.48
0.50
0.55
0.60
Shares Outstanding (12/31/07)
100,000
Cost of Equity
0.14
Cost of Debt
0.08
WACC(bt)
0.11
20. (Residual Income Valuation - sensitivity). Assume the residual income perpetuity in the
previous problem was changed to a -10% growth rate. By how much will this change the
estimated share price computed in the previous problem?
a. $0.44 higher
b. $0.98 higher
c. $1.46 higher
d. $5.37 higher
e. $5.91 higher
21. (AEG Valuation). Compute the dividend reinvestment income (DRIP) for 2010.
a. $6,270
b. $7,000
c. $7,700
d. $8,400
e. $9,595
22. (AEG Valuation). Assume the dividend reinvestment income (DRIP) in 2009 is $7,000
compute the AEG for 2009.
a. -$14,300
b. -$11,003
c. $0.00
d. $19,298
e. $22,000
23. (AEG Valuation). Assume that AEG is forecast to be -$10,000 in 2011 with a growth rate
of negative 50% per year, onwards. Estimate the intrinsic value of Hi-Flyer’s shares at
the end of 2007.
a. $8.29
b. $15.63
c. $16.07
d. $17.59
e. $33.66
End of Valuation Model Computation Section
Page 6 of 10
FSA 3321 (Moore-1)
Exam 4
Summer 2008
Use the following information to solve the following three (3) problems
Valuation with P/EBITDA, P/B and PEG multiples (Questions 24-26)
Ball Corp. is a manufacturer of packaging materials that you are trying to value. Using the
method of comparables, assess the value of Ball Corp. Information is provided concerning
the current share price (PPS), forward earnings per share (EPS), the current book value of
equity per share (BPS), EBITDA per share and the one-year ahead earnings growth rate for
Ball Corp. and three of its listed competitors.
Do not eliminate potential outliers in the following valuations.
Sealed Air Corp
Ball Corp
PactIV Corp
Crown Holdings
PPS
32.91
51.54
34.68
24.69
EPS
1.74
3.54
1.84
1.37
BPS
11.01
11.64
6.22
<3.14>
24. Value Ball Corp Using the Price to Book Ratio.
a. $2.72 per share
b. $14.93 per share
c. $49.85 per share
d. $50.41 per share
e. $51.54 per share
25. Value Ball Corp Using the Price to EBITDA Ratio.
a. $7.27 per share
b. $47.04 per share
c. $48.16 per share
d. $53.33 per share
e. $54.22 per share
26. Value Ball Corp Using the PEG Ratio.
a. $33.98 per share
b. $43.98 per share
c. $45.87 per share
d. $51.20 per share
e. $52.46 per share
Page 7 of 10
EBITDA
4.83
7.46
4.49
5.64
1 Year ahead
Earnings Growth
13.2%
9.6%
12.0%
20.5%
FSA 3321 (Moore-1)
Exam 4
Summer 2008
27. Old Reliable Manufacturing Company's stock has a book value of $15 per share and a
long-run ROE = 25%. You have estimated its cost of equity capital to be 16% and its book
value is expected to grow at 12% per year indefinitely. Compute Old Reliable’s intrinsic
share value using the long run average residual income perpetuity method?
a. $25.00
b. $25.56
c. $33.75
d. $48.75
e. $78.57
28. Old Reliable Manufacturing Company's stock has a market price of $52.40 per share and a
book value of $15 per share. You have estimated its steady state ROE to be 20 percent per
year and its expected growth rate in book value (in perpetuity) is 12%. What cost of equity
supports the current stock price?
a. 10.15%
b. 12.33%
c. 13.82%
d. 14.29%
e. 16.48%
Page 8 of 10
FSA 3321 (Moore-1)
Exam 4
Summer 2008
Consider the following information for Questions 29 through 31:
You have just estimated β for XYZ Corp. using the Capital Asset Pricing Model. Your
regression results follow. In addition, you also have performed research on the 10-K to get
the balance sheet information below. Your goal is to estimate the relevant costs of capital
for XYZ Corp. Assume that last year’s market return was 12% and the 10-year Treasury had
a yield of 4%. Also, you found the market risk premium over the last 3-years to be 7% and
that interest rates are not expected to change in the next 4 years. The Market Cap is $250
million and the tax rate is 30%
Balance Sheet (Millions)
Estimation
R
2
Period
β
5-Year
2.00
15.25%
3-Year
2-Year
1.50
1.30
18.45%
28.55%
Published β
1.40
2007
Total Assets
180
Current Liabilities
Long Term Liabilities
Long-term Debt
Pension Liabilities
Capital Leases
Book Value of Equity
10
4.00%
30
40
20
80
8.00%
12.00%
10.00%
29. Based on your analysis, compute the appropriate estimate of the cost of equity.
a. 13.1%
b. 13.8%
c. 14.4%
d. 14.5%
e. 18.0%
30.
31.
a.
b.
c.
d.
e.
Compute the Before-Tax weighted average cost of debt
8.5%
9.6%
10.0%
7.4%
8.0%
a.
b.
c.
d.
e.
Compute the Before Tax Weighted average cost of capital.
10.86%
11.16%
12.60%
12.10%
13.10%
Page 9 of 10
Average
Interest
Rate
FSA 3321 (Moore-1)
Exam 4
Summer 2008
Use the following Regression Output for Problems 32-33
This is the regression output for estimating Beta using CAPM.
SUMMARY OUTPUT
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
Coefficients
0.079
1.30
Intercept
X Variable 1
32.
Standard
Error
0.009
0.360
t Stat
P-value
Lower 95%
0.973
0.334
0.059
2.673
0.998
0.582
Upper
95%
0.09
2.02
Compute the upper and lower bounds on the cost of equity (95% confidence level).
Use the information from problems 29-31 and the regression output above.
a.
b.
c.
d.
e.
33.
0.2145
0.4603
0.2855
0.7152
60
4.63%
8.07%
8.07%
8.07%
4.63%
<
<
<
<
<
k
k
k
k
k
<
<
<
<
<
10.86%
13.10%
10.81%
18.14%
18.14%
What percentage of the firm’s return variability is not explained by the systematic risk
component?
a.
b.
c.
d.
e.
46.03%
28.55%
28.48
71.45%
0.20%
Page 10 of 10