FSA 3321 – Summer 1 (2010)
Exam 4
Moore
Examination 4 – Finance 3321
Summer 2010 (Moore)
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Clearly Circle the BEST response for each of the following questions:
1. Which of the following increases free cash flows to the firm (both equity and debt)?
a. A decrease in gross margins
b. An decrease in inventories
c. A decrease in dividends
d. A decrease in accounts payable
e. An increase in Plant, Property and Equipment
2. Consider a company with the following: Value of debt is 400 with kd of 8%. Further,
assume ke is 18%; rf = 5%; T = 35% and WACCAT = 12.88%. Computed WACCBT is:
a. 5.00%
b. 10.20%
c. 12.88%
d. 14.00%
e. 14.96%
3. Residual Income valuation models require which of the following discount factors?
a. WACC and the free cash flow 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
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FSA 3321 – Summer 1 (2010)
Exam 4
Moore
4. Assume a firm will pay its first dividend in 2 years. This initial period’s dividend is forecast
to be $3.00 per share for the first 3 years and then is expected to grow at 4% per year in
perpetuity. Assume WACC = 12%; the cost of equity is 16%; 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. $16.02
b. $20.17
c. $21.42
d. $21.82
e. $29.15
5. The present value (today) of the terminal (continuation) value cash flow that begins in 11
years is $28,174,758 assuming a WACC equal to 11%. The year 11 free cash flow
(beginning of the growing perpetuity) is $4,000,000. What is the growth rate required for
the continuation value term?
a. 5%
b. 6%
c. 7%
d. 8%
e. 9%
6. 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 increases
d. The market value of the equity increases
e. The share price will increase
7. 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 increasing, 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 positive for those periods.
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FSA 3321 – Summer 1 (2010)
Exam 4
Moore
8. 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%
9. Old Reliable Manufacturing Company's stock has a market price of $10.50 per share and
the market’s assessment of its steady state return on equity is 12% per year. Assume its book
value is expected to grow at 5 percent per year indefinitely, and the current book value per
share is $15.00? The computed cost of equity is:
a. 9%
b. 11%
c. 13%
d. 15%
e. 17%
10. You have just computed the Beta of a stock to be 2.5 and the estimate of the relevant riskfree rate is 5%. The expected market return next period is 12% and your estimate of K e
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%
11. Consider the Residual Income Valuation model and the sensitivity analysis you performed
on your projects by varying the cost of equity and the terminal value perpetuity growth rates.
Suppose you were looking at the valuations of XYZ company in a sensitivity analysis table and
find the price at the 15% Ke line to be $23.50 per share when a -10% terminal value growth
rate is use but $29.00 per share when you move to a -40% terminal value growth rate for the
same cost of equity. Which one of the following must be true?
a. The terminal value perpetuity begins as a negative value
b. The terminal value perpetuity begins as a positive value
c. The terminal value perpetuity begins at zero
d. Year by Year residual income is increasing
e. Year by Year residual income is decreasing
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FSA 3321 – Summer 1 (2010)
Exam 4
Moore
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)
Actual
Estimated Estimated Estimated
2007
2008
2009
2010
Net Income
225,000
200,000
215,000
230,000
Total Dividends Paid
48,000
20,000
25,000
30,000
Book Value of Equity
1,500,000
Total Liabilities
1,000,000
CFFO
400,000
150,000
200,000
250,000
CFFI
-250,000
-100,000
-200,000
-200,000
Dividends Per Share
0.48
0.20
0.25
0.30
Shares Outstanding (12/31/07)
100,000
Cost of Equity
0.14
Cost of Debt
0.08
WACC(bt)
0.11
12. 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 $0.35
and that it will growth by 8% per year in perpetuity. The appropriate intrinsic value is:
a. $3.933
b. $4.024
c. $4.504
d. $4.508
e. $4.988
13. (Sensitivity Analysis). You know that dividend growth rates are estimated with error. In
the previous problem, the dividend growth perpetuity was assumed to be 8% per year.
What would be the impact on share price if the growth rate were assumed to be 3% (all
other information remains the same).
a. $1.30 lower
b. $1.57 lower
c. $1.79 lower
d. $1.88 lower
e. no impact
14. (Time Consistent Prices). Assume the valuation date is December 1, 2008 and that you
computed a share price in Problem 31 of $2.00 per share. What is the time consistent price
that would be compared with the observed price of $2.50.
a. $2.112
b. $2.135
c. $2.231
d. $2.255
e. $2.280
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FSA 3321 – Summer 1 (2010)
(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
Moore
Actual
Estimated Estimated
2007
2008
2009
225,000
200,000
215,000
48,000
20,000
25,000
1,500,000
1,000,000
400,000
150,000
200,000
-250,000
-100,000
-200,000
0.48
0.20
0.25
100,000
0.14
0.08
0.11
Estimated
2010
230,000
30,000
250,000
-200,000
0.30
15. (Free Cash Flow Valuation). Assume that free cash flow to the firm is forecast to be
$70,000 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. -$0.65
b. $0.00
c. $0.816
d. $8.53
e. $9.35
16. (Residual Income). Compute the book value of equity at the end of 2010.
a. $1,320,000
b. $1,500,000
c. $1,680,000
d. $1,870,000
e. $2,070,000
17. (Residual Income Valuation). Compute the normal income for 2009.
a. $210,000
b. $228,000
c. $235,200
d. $245,100
e. $256,500
18. (Residual Income Valuation). Compute the intrinsic value of Hi-Flyer’s shares at the end of
2007. Assume residual income will be ($25,000) in 2011 (perpetuity start) with a growth
rate in the perpetuity of -40% per year.
a. $0.77
b. $12.69
c. $13.95
d. $14.23
e. $15.19
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FSA 3321 – Summer 1 (2010)
Exam 4
Moore
Actual
Estimated Estimated Estimated
2007
2008
2009
2010
Net Income
225,000
200,000
215,000
230,000
Total Dividends Paid
48,000
20,000
25,000
30,000
Book Value of Equity
1,500,000
Total Liabilities
1,000,000
CFFO
400,000
150,000
200,000
250,000
CFFI
-250,000
-100,000
-200,000
-200,000
Dividends Per Share
0.48
0.20
0.25
0.30
Shares Outstanding (12/31/07)
100,000
Cost of Equity
0.14
Cost of Debt
0.08
WACC(bt)
0.11
19. (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. $0.39 higher
b. $0.39 lower
c. $0.46 higher
d. $0.46 lower
e. $1.91 lower
(in thousands except per share data)
20. (AEG Valuation). Compute the dividend reinvestment income (DRIP) for 2010.
a. $6,720
b. $3,500
c. $2,800
d. $1,400
e. $1,095
21. (AEG Valuation). Assume the dividend reinvestment income (DRIP) in 2009 is $2,800
compute the AEG for 2009.
a. -$3,280
b. -$10,200
c. -$11,600
d. -$13,000
e. -$15,100
22. (AEG Valuation). Assume that AEG is forecast to be -$8,000 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 2007.
a. $8.29
b. $9.63
c. $10.07
d. $12.01
e. $13.66
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FSA 3321 – Summer 1 (2010)
Exam 4
Moore
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 23-25)
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>
23. 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
24. 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
25. Value Ball Corp Using the PEG Ratio.
a. $33.98 per share
b. $43.98 per share
c. $45.87 per share
d. $51.04 per share
e. $52.46 per share
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EBITDA
4.83
7.46
4.49
5.64
1 Year ahead
Earnings Growth
13.2%
9.6%
12.0%
20.5%
FSA 3321 – Summer 1 (2010)
Exam 4
Moore
26. Why must terminal value perpetuities for the residual income and AEG models have
negative growth rates?
a. You must have positive residual income or AEG.
b. You must always outperform your cost of capital in the perpetuity
c. You must always underperform your cost of capital in the perpetuity
d. Negative growth rates ensure you return to the equilibrium cost of capital, eventually.
e. Positive growth rates always cause Residual Income or AEG to become more positive.
27. You computed XYZ Company to have AEG of $15,000 in 2009, $11,900 in 2010 and
$12,376 in 2011. Net Income is forecast to be $380,000 in 2009, $480,000 in 2010 and
$500,000 in 2011. Residual Income is forecast to be $85,000 in 2009 and $96,900 in
2010. Assuming a cost of equity of 14%, the residual income computed for 2011 is:
a. $70,000
b. $109,276
c. $110,466
d. $120,400
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FSA 3321 – Summer 1 (2010)
Exam 4
Moore
Consider the following information for Questions 28 through 30 (3 points each):
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 3.69%. Also, you found the market risk premium over the last 3-years to be 8% and
that interest rates are not expected to change in the next 4 years. The Market Cap is $1,300
million and the tax rate is 30%. Regression output for XYZ may be found on Page 11 of the
exam booklet.
Balance Sheet (Millions)
Total Assets
Current Liabilities
Published β
Long Term Liabilities
Long-term Debt
Pension Liabilities
Capital Leases
Book Value of Equity
1.60
2009
2,200
300
3.00%
600
200
100
1,000
8.00%
6.00%
9.00%
28. Based on your analysis, compute the appropriate estimate of the cost of equity.
29.
Compute the Before-Tax weighted average cost of debt
30.
Compute the After-Tax Weighted average cost of capital.
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Average
Interest
Rate
FSA 3321 – Summer 1 (2010)
31.
Exam 4
Moore
Compute the upper and lower bounds on the cost of equity (95% confidence level).
Use the information from problems 28-30 and the regression output on the next page.
The following table contains stock price and dividend data for AIG. Use this info for 32 &33.
Date
Open
High
Low
Close
Mar-2010
27.96
38.45
24.5
34.45
Feb-2010
24.38
29.3
21.54
24.77
Jan-2010
30.53
30.54
23.04
24.23
Dec-2009
29.58
32.8
27.4
29.98
Nov-2009
34.42
40.09
28.04
28.4
Oct-2009
43.57
47.42
33.02
33.62
Sep-2009
41.04
54.4
32.66
44.11
Aug-2009
13.29
55.9
12.97
45.33
Jul-2009
19.65
22.96
8.22
13.14
24-Jul-2009 $ 1.00 Dividend
04-Jul-2009 1 : 20 Stock Split
Jun-2009
1.7
1.74
1.08
1.16
32.
Compute the stock return for July 2009 using the information below for AIG. Note they
had a reverse split of 1:20 on July 4, 2009. (4 Points)
33.
Compute the August 2009 stock return AIG. (3 points)
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FSA 3321 – Summer 1 (2010)
Exam 4
Moore
SUMMARY OUTPUT
Regression Statistics
Multiple R
0.6283
R Square
0.3948
Adjusted R Square
0.3862
Standard Error
0.1069
Observations
72
Coefficients Standard Error
Intercept
0.02
0.01
X Variable 1
1.98
0.29
t Stat P-value Lower 95%
Upper 95%
1.69
0.10
0.00
0.05
6.76
0.000
1.40
2.56
SUMMARY OUTPUT
Regression Statistics
Multiple R
0.6713
R Square
0.4507
Adjusted R Square
0.4412
Standard Error
0.1039
Observations
60
Coefficients Standard Error
Intercept
0.01
0.01
X Variable 1
2.01
0.29
t Stat P-value Lower 95%
Upper 95%
1.03
0.31
-0.01
0.04
6.90
0.00
1.43
2.59
SUMMARY OUTPUT
Regression Statistics
Multiple R
0.6846
R Square
0.4686
Adjusted R Square
0.4571
Standard Error
0.1054
Observations
48
Coefficients Standard Error
Intercept
0.01
0.02
X Variable 1
1.92
0.30
t Stat P-value Lower 95%
Upper 95%
0.78
0.44
-0.02
0.04
6.37
0.00
1.32
2.53
SUMMARY OUTPUT
Regression Statistics
Multiple R
0.7274
R Square
0.5291
Adjusted R Square
0.5152
Standard Error
0.1062
Observations
36
Coefficients Standard Error
Intercept
0.01
0.02
X Variable 1
1.92
0.31
t Stat P-value Lower 95%
Upper 95%
0.37
0.71
-0.03
0.04
6.18
0.00
1.29
2.55
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