MSF 503 Assignment #2

1. Examine Cisco’s consolidated statement of cash flows (see in Excel Spreadsheet) and transform this
into a free cash flow.

2. Below are some year-end numbers for Cisco’s equity. Restate the enterprise value in market terms.

3. ABC Corp. has a stock price P0= 50. The firm has just paid a dividend of $3 per share, and intelligent
shareholders think that this dividend will grow by a rate of 5% per year. Use the Gordon dividend
model to calculate the cost of equity of ABC.

4. It is 1 January 1997. Normal America, Inc. (NA) has paid a year-end dividend in each of the last 10
years, as shown by the table below:

a. Calculate NA’s β with respect to the S&P 500.

b. Suppose that the Treasury bill rate is 5.5% and that the expected return on the market is E(r M ) = 13%.
If the corporate tax rate TC = 35%, calculate NA’s cost of equity using both the classic CAPM and tax-
adjusted model.

c. Assume that NA ’ s cost of debt is 8%. If the company is financed by 1/3 equity and 2/3 debt, what is
its weighted average cost of capital using each of the two CAPM models?

5. The template for Problem #4 gives the 10-year history of Intel’s quarterly dividends. Compute Intel’s
cost of equity rE using the Gordon dividend model. Compare the cost of equity computed on the basis
of 10 years of growth with that computed on the last 5 years of growth.
 MSF 503 Assignment #2

6. Dismal.Com is a producer of depressing Internet products. The company is currently not paying
dividends, but its chief financial officer thinks that starting in 3 years it can pay a dividend of $15 per
share, and that this dividend will grow by 20% per year. Assuming that the cost of equity of
Dismal.Com is 35%, value a share based on the discounted dividends.

7. (optional) The “Model for Reference” in the Excel file includes costs of goods sold but not selling,
general, and administrative (SG&A) expenses. Suppose that the firm has $200 of these expenses each
year, irrespective of the level of sales.

(a) Change the model to accommodate this new assumption. Show the resulting profit and loss
statements, balance sheets, the free cash flows, and the valuation.

(b) Do a data table in which you show the sensitivity of the equity value to the level of SG&A. Let SG&A
vary from $0 per year to $600 per year.

8. (optional) Back to the basic model in the given Excel sheet (“Model for Reference”). Suppose that the
fixed assets at cost follow the following step function:

{
100 ∗Sales if S ales ≤1200
Fixed Assets at Cost= 1,200+ 90 ∗( Sales−1,200 ) 1200< Sales ≤1400
1380+80 ∗( Sales−1400 ) Sales>1400

Incorporate this function into the model.

9. (optional)

(a) In the valuation exercise given in the excel spreadsheet (“Model for Problem 9”), the terminal value is
calculated using a Gordon dividend model on the cash flows. Replace this terminal value by the year 5
book value of debt+ equity. This means that you are essentially assuming that the book value correctly
predicts the market value.

(b) Repeat the above exercise, but this time replace the terminal value by an EBITDA (earnings before
interest, taxes, depreciation, and amortization) ratio times year-5 anticipated EBITDA. Show a graph of
the equity value of the firm as a function of the assumed year 5 EBITDA ratio, varying this ratio from 6–
14.