20127 CORPORATE FINANCE (Business valuation)
Mock Exam
Length: 1 h
The use of calculators is allowed.
7
Values
must be rounded to second decimal.
Values must be rounded to second decimal.
Forename
…………………………………..
Surname
…………………………………..
Group
Name
(Homework)
……………………......................
1
QUESTION 1
You are asked to value Preda, a fashion company. Currently (at time 0), the book value of Preda’s
gross financial debt is =€22.22 Billion, while the book value of the equity is =€12.65 Billion.
The target leverage ratio (D/E) for the company is going to be = 55%, and you know that the
corporate marginal tax rate (t) is 30%, the risk-free rate (Rf) is = 2.85%, the relevant Equity Risk
Premium (ERP) is = 5.5%, and that Preda’s default spread is = 2.35%.
You are also provided with some information concerning the financial forecasts for the company
(Table 1), and with data related to the three main competitors of Preda (which are all assumed to be
validly comparable to the company): G&D, Armeni, and Svalentine (Table2).
a) Assuming a tax rate = 30% for all the three comparables (G&D, Armeni, and Svalentine),
compute the adjusted beta for each comparable and estimate the industry beta (β) and the
unlevered cost of equity (ku) for Preda. (3 marks)
b) Estimate the levered cost of equity (ke) and the weighted average cost of capital (WACC ) for
Preda. (2 marks)
c) On the basis of the financial data in the table, and assuming that after the explicit forecast
period Preda will have a stable growth rate (gn) = 2.5%, estimate both the Enterprise Value
and the Equity Value using the Free Cash Flow to Firm (FCFF) approach. (4 marks)
d) Estimate Preda’s Equity Value using the relative valuation approach on the basis of the
information about the three comparables. In particular, you are requested to apply the P/E,
the EV/Sales, and the P/BV multiples. (3 marks)
e) The gross financial debt of Preda does include a convertible bond with yearly coupon rate of
5.5%, and face value =€2.4 Billion which will mature at the end of Year 3. The current market
value of the convertible bond issue is =€2.95 Billion. What is the value of the issue’s equity
component? (1 mark)
2
Table 1: FORECASTS FOR PREDA (€ million)
Today
Cash & cash equivalents
340
Inventory
952
Receivables
1.394
Payables
1.768
Capital Expenditures
2.448
Divestitures
43
Revenues
65.280
EBITDA
5.875
Depreciation & Amortization
1.306
EBIT
4.570
Net interest expenses
3.199
Pre-tax income
1.371
Taxes
411
960
Net Income
Year 1
357
1.000
1.464
1.856
2.570
45
68.544
6.169
1.371
4.798
3.359
1.439
432
1.008
Year 2
375
1.050
1.537
1.949
2.699
71.971
6.477
1.439
5.038
3.527
1.511
453
1.058
Year 3
394
1.102
1.614
2.047
2.834
75.570
6.801
1.511
5.290
3.703
1.587
476
1.111
Table 2: COMPARABLES FOR PREDA (€ million)
FINANCIAL STATEMENTS
Cash & cash equivalents
Inventory
Receivables
Intangible assets
Fixed assets
Total assets
G&D
1350
3375
4590
5670
16045
31030
Comparables
Armeni
1012
2530
3441
4250
31045
42278
Svalentine
790
1975
2686
3318
6906
15675
Short-term financial debt
Payables
Long-term financial debt
Book value of the equity
Total liabilities & equity
1300
2730
4900
22100
31030
3560
4628
5290
28800
42278
2250
2475
2450
8500
15675
62060
31030
26686
4344
1086
84556
42278
36359
5919
1480
31350
15675
13481
2195
549
24900
1,25
32800
1,15
9120
0,95
0.52
0.46
0.60
Revenues
Variable costs
Fixed costs
EBIT
Net Income
MARKET INFORMATION
Market value of the equity (mkt cap)
Raw beta (β )
Correlation coefficient (ρ )
3
QUESTION 2
BioTex, a biotechnology company, treats all its R&D expenses as operating expenses. While this
approach is coherent and compliant with local accounting standards, from a financial point of view
this is a biased representation of firm’s economics. In fact, the value of the assets created by
research does not show up on balance sheet as part of the total assets of the company. For
valuation purposes you are asked to estimate the financial value of these assets.
Table 3 shows all the R&D expenses made by BioTex since its inception.
Table 3: R&D expenses for BioTex (€ million)
Year
R&D Expenses
Current
2011
2010
2009
2008
2007
2006
245
222
378
245
240
186
Firm not in existence
a) Assuming that all these expenses could be amortized linearly over time with a 10-year life,
estimate the current value of the research asset created by BioTex, and the amortization of
R&D expenses in the current year (2012 is not yet over). (2 marks)
b) Knowing that the operating income and the net income are going to be respectively =€785mln
and =€512mln in 2012, compute both the adjusted operating earnings and the adjusted net
income for BioTex. (1 mark)
c) With reference to the current year, the book value of the equity of BioTex is =€1512mln.
Estimate both the adjusted book value of equity and the adjusted Return On Equity (ROE). (1
mark)
d) With reference to the current year, the book value of the capital of BioTex is =€2812mln.
Estimate both the adjusted book value of capital and the adjusted (pre-tax) Return On Capital
(ROC). (1 mark)
Multiple Choice Questions
[1 mark for each correct question, no penalty for wrong answers]
1. In valuation, your risk free has to be a long term, default-free rate. When valuing a company
in US dollars, we often use the 10-year US T. bond rate as the risk-free rate. In the last few
years, there have been questions about whether the US treasury is really default-free. If you
4
2.
3.
4.
5.
share these concerns, which of the following will you do, assuming that you are still
estimating cash flows in US dollars?
a. Continue to use it the 10-year bond rate the risk-free rate since you have no choice
b. Switch to using the US treasury bill rate, since default is less likely in the short term
c. Estimate a default spread for the US government and reduce the treasury bond rate
by that spread
d. Use the rate on a 10-year Swiss Government bond, denominated in Swiss francs
(since the Swiss government has no default risk)
e. None of the above
A key input into your terminal value is the expected growth rate in perpetuity. Assuming
that you are valuing a company in a currency with a risk-free rate of 3%. Which of the
following growth rates is not feasible?
a. -3% in perpetuity
b. 0% in perpetuity
c. 2% in perpetuity
d. 4% in perpetuity
e. None of the above
Tinga Inc., a poorly run restaurant chain, is currently fairly valued, based on the expectation
that it would generate $25 million in after-tax operating income next year, growing at 2% a
year. The company has $500 million in invested capital and is expected to maintain its
current return on investment capital; its cost of capital is 8%. You believe that you can run
the firm better and double its aftertax operating income without adding any invested
capital. Assuming that you can maintain your return on capital in perpetuity as well, how
much of a control premium (in percentage terms, over and above current value) would you
be willing to pay for Tinga?
a. 20%
b. 100%
c. 167%
d. 200%
e. None of the above
You are reading an analyst reports that claims that banks collectively are cheap, because
they are trading at 0.80 times book value of equity. You believe that the truth is that banks
are perceived as riskier than they used to be. If the current return on equity for banks is 10%
and the expected growth rate in perpetuity is 2%, what is the cost of equity that investors
are attaching to banks? (Assume that banks collectively are in stable growth)
a. 8%
b. 12%
c. 12.5%
d. 15%
e. None of the above
You are trying to compute the levered beta that you will use to value Abel Stores. The
company has a book value of equity of $600 million and a book value of debt of $ 600
million. If the typical apparel store company trades at three times book value of equity and
the market value of debt = book value of debt, what is the debt to equity ratio that you will
use to compute the levered beta for Abel Stores? (The marginal tax rate is 40%)
a. 25%
5
b. 33.33%
c. 100%
d. 300%
e. None of the above
6. The key driver of revenue multiples is profit margins. Which of the following measures of
profit margin is the most direct determinant of price to sales ratios?
a. Net Profit margin
b. Gross profit margin (Gross profit/Sales)
c. Pre-tax operating margin (EBIT/Sales)
d. After-tax operating margin (After tax EBIT/Sales)
e. EBITDA margin
Essay Question (up to 4 marks)
Discuss the rationale of the paper “New Evidence and Perspectives on Mergers” by Andrade,
Mitchell and Stafford (2001), the drivers of mergers and the practical implications on valuation.
6