Seminar 9 N1591

Valuation of Companies and Cash Flow Generating Assets (N1591)

Autumn Term 2019/20

Seminar 9: Calculating and Interpreting Results (McK Chap 15)

Essay and Calculation Questions

1. Consumer Products Co reports growth by segment in the “Management’s

Discussion and Analysis” section of its annual report (Exhibit 15.6) for a given year.

 Does each segment have the same organic growth characteristics?

 As an approximation, if organic growth equals the sum of the Volume Excluding
Acquisitions and Divestitures, Price and Other, can Consumer Products Co be
modelled as a whole, or should the individual segments be modelled
separately?

2. You are valuing DistressCo, a company struggling to hold market share. The
company currently generates $ 120m in revenue, but its revenue is expected to shrink
to $ 100m next year. Cost of sales currently equals $ 90m and depreciation equals
$ 18m. Working capital equals $ 36m and PP&E equals $ 120m.

Using this data, construct operating profit and invested capital for the current year. You
decide to build an as-is valuation of DistressCo. To do this, you forecast each ratio (as
percentage of revenue) at its current level.

Based on this forecast method, what are operating profits and invested capital
expected to be next year? What are two critical operating assumptions (identify one for
profits and one for capital) embedded in this forecast method?

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3. You decide to value a steady-state company using probability-weighted scenario

analysis.

In Scenario 1, NOPLAT is expected to grow at 6% and ROIC equals 16%. In Scenario

2, NOPLAT is expected to grow at 2% and ROIC equals 8%. Next year’s NOPLAT is
expected to equal $ 100m and the weighted average cost of capital is 10%.

Using the Key Value Driver formula introduced in Chapter 2, what is the enterprise
value in each scenario? If each scenario is equally likely, what is the enterprise value
for the company?

4. A colleague recommends a shortcut to value the company in Question 3. Rather

than compute each scenario separately, he recommends averaging each input, such
that growth equals 4% and ROIC equals 12%.

Will this lead to the same enterprise value found in Question 3? Which method is
correct? Why?

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Multiple Choice Questions

5. In a scenario analysis, which of the following are considerations when reviewing the
assumptions of a model?

I) The sensitivity of the results to broad economic conditions.

II) The level of competitiveness of the industry.
III) The internal capabilities of the company to achieve the forecasts of output
and growth.
IV) The ability of the company to raise the necessary capital from the markets.

A. I and II only.
B. II and III only.
C. I, III, and IV only.
D. All of the above.

6. When making forecasts, increasing one variable usually means decreasing another.
Which of the following are possible common trade-offs that should be considered in
making such forecasts?

I. Product volume and prices.

II. Lower inventory and higher sales.
III. Higher growth and lower margin.

A. I and II.
B. I and III.
C. II and III.
D. All of the above.

7. What is the purpose of sensitivity analysis?

I. For senior managers to prioritise actions most likely to affect value materially.
II. Examine the impact of different economic scenarios on value.
III. For investors to focus on which inputs to investigate further and monitor more
closely.
IV. Help bound valuation if uncertainty about inputs.

A. I, II and III only.

B. III and IV only.
C. I, III and IV only.
D. All of the above.

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8. What would demonstrate the robustness of a forecasting model?

A. Low growth rates.

B. Stable ROIC.
C. A balance sheet that balances.
D. High profit margins.

9. An economically consistent model would be expected to show that:

I. Patterns are intended.

II. Patterns are reasonable.
III. Patterns are consistent with industry dynamics.
IV. Steady state is reached at the end of the explicit forecast period.

A. I, II and III only.

B. III and IV only.
C. I, III and IV only.
D. All of the above.

10. To prioritise strategic actions, the analyst should:

A. Take a vote from the major players.

B. Build a sensitivity analysis that tests multiple changes at a time.
C. Follow the priorities of leaders in the industry.
D. Follow Porter’s five forces analysis.