FSA 3321 (Moore-1)
Exam 4
Summer 2009
Exam 4 - Finance 3321 (Moore) – Summer 2009
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1. Which of the following decreases free cash flows to the firm (both equity and debt)?
a. An increase in net income
b. An decrease in inventories
c. An increase in dividends
d. A decrease in accounts payable
e. A decrease 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 WACCBT would be:
a. 4%
b. 12%
c. 14.8%
d. 16%
e. 18%
3. Which of the following is not an underlying assumption or consequence of AEG valuation
models?
a. Dividend policy irrelevance
b. Convergence to equilibrium returns
c. Measurement of direct and indirect wealth effect flows to shareholders from the firm
d. Creation of shareholder wealth through changes in dividend policy
4. Assume a firm will pay its first dividend in 2 years. This initial period’s dividend is forecast
to be $2.00 per share. Then, the dividend in year three is expected to be $2.50 and it
will 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. $24.05
b. $25.58
c. $31.25
d. $32.79
e. $34.58
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FSA 3321 (Moore-1)
Exam 4
Summer 2009
5. Which is the only valuation model that explicitly takes into consideration the current
characteristics and current tangible net worth of a company being valued?
a. Discounted Dividends valuation
b. Discounted Free Cash valuation
c. Residual Income valuation
d. Abnormal Earnings Growth (AEG) valuation
e. Forward Price to Earnings multiple valuation
6. The present value (today) of the terminal perpetuity that begins in 11 years is
$12,000,000 when the cost of capital is equal to 16%. The year 11 seed value to the
perpetuity $13,763,677. What is the growth rate of the perpetuity?
a. -20%
b. -10%
c. 5%
d. 7%
e. 9%
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 1.8 to 0.9?
a. The firms cost of equity decreases by 50%
b. The firm’s cost of equity increases
c. The WACC of the firm decreases
d. The market value of the equity decreases
e. The market risk premium decreases
8. Which is correct regarding the Abnormal Earnings Growth valuation model?
a. Because the model incorporates cumulative dividend earnings, firms can create
shareholder value by changing dividend policy.
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 12% per year into
the foreseeable future. What terminal value growth rate is most appropriate for the free
cash flow valuation model when WACC is 12%?
a. -10%
b. 0%
c. 2%
d. 7%
e. 12%
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FSA 3321 (Moore-1)
Exam 4
Summer 2009
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 book value of equity of $30 per share
and the market’s assessment of its steady state return on equity is 20% per year. If its cost
of equity capital is 14 percent and its book value is expected to grow at 11.6 percent per
year indefinitely, what is the appropriate share price?
a. $45.00
b. $65.00
c. $75.00
d. $105.00
e. $135.00
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 9
FSA 3321 (Moore-1)
Exam 4
Summer 2009
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
2008
2009
2010
225,000
200,000
225,000
48,000
40,000
45,000
1,500,000
1,000,000
400,000
250,000
275,000
-250,000
-200,000
-250,000
0.48
0.40
0.45
100,000
0.14
0.08
0.11
Estimated
2011
275,000
50,000
350,000
-300,000
0.50
13. Using the above forecasts, determine the intrinsic value of High Flyer shares. Use the
discounted dividends model; assume the forecast dividend payment in 2012 is $0.60
and that it will grow by 4% per year in perpetuity. The appropriate intrinsic value is:
a. $1.03
b. $4.05
c. $5.08
d. $7.03
e. $8.95
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 4% 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. $1.02 higher
b. $1.50 higher
c. $2.10 higher
d. $2.31 higher
e. $2.70 higher
15. (Time Consistent Prices). Assume the valuation date is May 1, 2009 and that you
computed a share price in Problem 13 of $6.00 per share. What is the time consistent price
that would be compared with the observed price on May 1, 2009.
a. $5.73
b. $6.00
c. $6.27
d. $6.54
e. $6.91
Page 4 of 9
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 2009
Estimated Estimated Estimated
Actual
2011
2010
2009
2008
275,000
225,000
200,000
225,000
50,000
45,000
40,000
48,000
1,500,000
1,000,000
350,000
275,000
250,000
400,000
-300,000
-250,000
-200,000
-250,000
0.50
0.45
0.40
0.48
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
$60,000 in 2012 and that it is expected to grow by 5% per year thereafter. The
estimated intrinsic value per share is (12/31/08):
a. -$1.67
b. $0.00
c. $1.02
d. $7.31
e. $8.33
17. (Residual Income). Compute the book value of equity at the beginning of 2010.
a. $1,660,000
b. $1,700,000
c. $1,840,000
d. $1,885,000
e. $2,065,000
18. (Residual Income Valuation). Compute the residual income for 2009.
a. -$5,694
b. -$7,400
c. -$8,772
d. -$10,000
e. $0.00
19. (Residual Income Valuation). Compute the intrinsic value of Hi-Flyer’s shares at the end
of 2008. Assume residual income will be $20,000 in 2012 (perpetuity start) with a growth
rate in the perpetuity of -20% per year.
a. $0.37
b. $12.69
c. $15.10
d. $15.37
e. $16.66
Page 5 of 9
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 2009
Estimated Estimated Estimated
Actual
2011
2010
2009
2008
275,000
225,000
200,000
225,000
50,000
45,000
40,000
48,000
1,500,000
1,000,000
350,000
275,000
250,000
400,000
-300,000
-250,000
-200,000
-250,000
0.50
0.45
0.40
0.48
100,000
0.14
0.08
0.11
20. (Residual Income Valuation - sensitivity). Assume the residual income perpetuity in the
previous problem was changed to a -50% growth rate. By how much will this change the
estimated share price computed in the previous problem?
a. $0.19 lower
b. $0.19 higher
c. $0.40 lower
d. $0.40 higher
e. $15.18 higher
21. (AEG Valuation). Compute the dividend reinvestment income (DRIP) for 2010.
a. $5,600
b. $6,300
c. $6,720
d. $8,400
e. $9,595
22. (AEG Valuation). Compute the AEG for 2011.
a. $1,300
b. $2,600
c. $6,720
d. $19,400
e. $24,800
23. (AEG Valuation). Assume that AEG is forecast to be $10,000 in 2011 with a growth rate
of negative 30% per year, onwards. Estimate the intrinsic value of Hi-Flyer’s shares at
the end of 2008.
a. $16.72
b. $17.06
c. $18.07
d. $19.59
e. $20.66
Page 6 of 9
FSA 3321 (Moore-1)
Exam 4
Summer 2009
24. Assume the AEG for Hi-Flyer is $2,600 in 2010. How much of the model’s market value of
equity is created by the earnings in 2010?
a. cannot be determined from the information provided
b. $2,281 created
c. $2,600 created
d. $16,291 created
e. $18,571 created
End of Valuation Model Computation Section
Use the following information to solve the following three (3) problems
Valuation with P/EBITDA, P/B and PEG multiples (Questions 25-27)
Sealed Air Corp. is a manufacturer of packaging materials that you are trying to value.
Using the method of comparables, assess the value of Sealed Air. 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 Sealed Air. 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>
25. Value Sealed Air using the Price to Book Ratio.
a. $28.93 per share
b. $34.39 per share
c. $49.85 per share
d. $55.07 per share
e. $61.54 per share
26. Sealed Air Corp using the Price to EBITDA Ratio.
a. $6.34 per share
b. $17.04 per share
c. $28.16 per share
d. $30.61 per share
e. $34.22 per share
27. Value Sealed Air Corp using the PEG Ratio.
a. $30.37 per share
b. $33.98 per share
c. $35.87 per share
d. $41.20 per share
e. $42.46 per share
Page 7 of 9
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 2009
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%
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 5%. 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%
Estimation
R
2
Balance Sheet (Millions)
2008
Total Assets
200
Period
β
5-Year
2.00
35.25%
3-Year
1.50
18.45%
Current Liabilities
30
4.00%
2-Year
1.30
28.55%
Long Term Liabilities
Long-term Debt
30
8.00%
Pension Liabilities
Capital Leases
Book Value of Equity
40
20
80
9.00%
12.00%
Published β
1.40
29. Based on your analysis, compute the appropriate estimate of the cost of equity.
a. 13.1%
b. 14.1%
c. 14.8%
d. 19.0%
30.
a.
b.
c.
d.
Compute the Before-Tax weighted average cost of debt
8.0%
9.0%
10.0%
11.0%
a.
b.
c.
d.
Compute the Before Tax Weighted average cost of capital.
10.9%
12.8%
14.6%
15.4%
31.
Average
Interest
Rate
Page 8 of 9
FSA 3321 (Moore-1)
Exam 4
Summer 2009
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
0.3603
0.3285
0.7152
60
4.63%
9.07%
9.07%
9.07%
4.63%
<
<
<
<
<
k
k
k
k
k
<
<
<
<
<
10.86%
14.10%
10.81%
19.14%
19.14%
What percentage of the firm’s return variability is explained by the systematic risk
component?
a.
b.
c.
d.
e.
21.45%
32.85%
36.03%
63.97%
67.15%
Page 9 of 9