Finals

Problem 1 Grading template
Part a
Base year 1 2 3 4 5
Risk-adjusted $5,000.00 $5,500.00 $6,050.00 $6,655.00 $7,320.50 $8,052.55
Book Equity $750.00 $880.00 $1,028.50 $1,197.90 $1,390.90 $1,610.51 1. Error on net income projection: -1/2 poin
Reguluatory C 15.00% 16.00% 17.00% 18.00% 19.00% 20.00% 2. Error on estimating reinvestment: -1 poin
3. Math errors: -1/2 point each
Net income $150.00 $165.00 $181.50 $199.65 $219.62 $241.58
- Reinvestment $130.00 $148.50 $169.40 $193.00 $219.62
FCFE $35.00 $33.00 $30.25 $26.62 $21.96
ROE 20.00% 18.75% 17.65% 16.67% 15.79% 15.00%
Part b
Return on equ 15.00%
Expected grow 3.00% 1. Wrong ROE: -1 point
Payout ratio 80.0% 2. Did not use net income in year 6: -1 poin
Cost of equit 9.00% 3. Did not compute payout ratio correctly: -
Expected net $248.82 4. Math errors: -1/2 point each
Expected FCFE $199.06
Terminal valu $3,317.65
Part c
FCFE $35.00 $33.00 $30.25 $26.62 $21.96 1. Discounted terminal value at wrong rate:
Terminal Value $3,317.65 2. Did not consider PV of FCFE for first 5
PV (at 12%) $31.25 $26.31 $21.53 $16.92 $1,894.99 3. Tried to use option value approach (with
Value of equi $1,990.99 4. Errors on treasury stock approach: -1 po
+ Exercise p 200
Value of equi $2,190.99
Number of sh 60
Value per sha $36.52
Problem 2
Part a
Expected gro 80%
Operating ma -50% 1. Wrong input into regression: -1/2 point each
Earnings Du 1 2. Did not multiply by right revenue: -1/2 point
Expected EV/ 22.8
Sales today = 10
EV today = 228
Part b
Expected gro 10% 1. Wrong input into regression: -1/2 point each
Operating ma 20% 2. Did not multiply by right revenue: -1/2 point
Earnings Du 0
Expected EV/S 10.3
Sales in year $188.96
EV at the end $1,946.26
Part c
EV at the end $1,946.26 1. Did not net out debt in year 5: -1 point
- Debt (20% $389.25 2. Did not compute PV of terminal value: -1 point
Value of equi $1,557.00 3. Did not net out current value of equity: -1 point
Cost of equity $0.15 Value of equity today = PV of FCFE for next 5 years + PV of equity at end of year 5
PV of equity $774.11
Value of equi $228.00
PV of FCFE fo $546.11 ! This is the PV of new equity issues for next 5 years
Problem 3
Griffin Leblow Combined
Revenues $2,000 $1,000 $3,000
Expected EBI $200 $150 $420
Tax rate 40% 40% 40%
Beta (Levere 1.2 1.2 1.31180124
Debt to capita 20% 20% 30%
Cost of equit 9.20% 9.20% 9.87%
Pre-tax cost o 4.00% 4.00% 4.00%
Expected grow 2% 2% 2%
Invested capit $1,200.00 $900.00 $2,100.00
Parts a &b
EBIT (1-t) 120 90 1. Did not compute cost of capital correctly: -1/2 point
Return on inv 10.00% 10.00% 2. Did not compute reinvestment rate correctly: -1/2 point
Cost of capita 7.8400% 7.8400% 3. Math errors: -1/2 point each
Reinvestment 20.0% 20.0%
Enterprise Va $1,643.84 $1,232.88
Part c
EBIT (1-t) 252
Return on inv 12.00% 1. Did not compute new cash flow correctly: -1/2 point
Cost of capita 7.63% 2. Did not recompute reinvestment rate correctly: -1/2 poin
Reinvestment 16.67% 3. Forgot to relever beta: -1 point
Enterprise Va 3730.30584 4. Math errors: -1/2 point each
Value of Syn $853.59
Problem 4
Status Quo Change in Control
Revenues 500 750
Pre-tax Oper $60.00 80
Tax Rate 40% 30%
Invested capit 400 500
Risk free rate 2.50% 2.50%
Beta 1.00 1.15
Cost of Equit 8.50% 10.55%
Pre-tax cost of debt 4.50%
Debt ratio 0.00% 20%
Cost of capita 8.50% ###
Expected gro 2.50% 2.50%
Part a
Expected grow 2.50% 1. Did not compute cost of capital correctly: -1/2 point
ROIC = 9.00% 2. Did not compute reinvestment rate correctly: -1/2 point
Reinvestment 27.78% 3. Math errors: -1/2 point each
Value of ente $433.33
Part b
Return on cap 11.20% 1. Did not estimate after-tax income correctly: -1/2 point
Reinvestment 22.32% 2. Did not estimate reinvestment rate correctly: -1/2 pont
Value of ente $671.30 3. Did not relever beta: -1/2 point
- Upfront in $100.00 4. Did not estimate after-tax cost of debt correctly: -1/2 point
Net value $571.30 5. Did not net out upfront cost: -1/2 point
Problem 5
Part a
Most recent yearStart of most recent year
Revenues $2,000 Net Fixed As $1,300
EBITDA $500 Cash $100
EBIT $400 Non-cash Cur $200
Interest expe $50 Total Asse $1,600
Taxable Inco $350 Non-debt Curr $100
Taxes $105 Debt $500
Net Income $245 Equity $1,000
Total Liabi $1,600
Effective tax 30%

After-tax ope $280.00 1. Estimated after-tax operating income incorrectly: -1/2 to -1 point
Invested Capi $1,400 2. Did not estimate reinvestment rate correctly: -1/2 point
Return on inv 20% 3. Math errors: -1/2 point each
Expected grow 2%
Reinvestment 10.0%
Value of Oper $4,284.00
Part b
Annual cash 470 ! (50*10 - 40 ! Don't forget depreciation & taxes
PV over 10 yea $3,153.74 1. PV of cash flows wrong: -1 point
2. Error on other inputs: -1/2 point each
Stock Pri ### Annualized continuou2.00% 3. Error on option valuation: -1 to -2 points (depending on magnitude)
Strike Pri ### Variance= 0.09

Expiration 10 Annualized dividend 0.00%
d1 = 0.434596
N(d1) = 0.668072
d2 = -0.51409
N(d2) = 0.303596
Value of the call = $1,112.67 Value of the put = $1,233.86

net income projection: -1/2 point
estimating reinvestment: -1 point
ors: -1/2 point each
se net income in year 6: -1 point

ompute payout ratio correctly: -1/2 point
ed terminal value at wrong rate: -1/2 point

onsider PV of FCFE for first 5 years: -1 point
use option value approach (without information): -1 point
treasury stock approach: -1 point
ctly: -1/2 point
orrectly: -1/2 point
ectly: -1/2 point

correctly: -1/2 poin
ctly: -1/2 point
orrectly: -1/2 point
rectly: -1/2 point

rrectly: -1/2 pont
t correctly: -1/2 point
incorrectly: -1/2 to -1 point

rrectly: -1/2 point
ints (depending on magnitude)

Problem 1 Grading Template
Normalized after-tax operating income = 150 1. Did not normalize earnings correctly: -1 p
Invested Capital = 1250 2. Did not recompute ROIC: -1 point
Normalized return on capital = 12.00% 3. Did not use reinvestment rate: -1 point
Expected growth rate in normalized inc 1.50% 4. Math errors: -1/2 point each
Reinvestment Rate = 12.500%
Value of operating assets = 2187.5
Value of operating assets = $2,187.50

+ Cash $250.00 1. Incorrect value for minority holding in R
+ Minority holding in RigWorks $100.00 (50*(.14-.02)/(.08-.02)) 2. Did not adjust for options correctly: -1 po
- Debt $1,000.00 3. Did not add cash/ subtract debt: -1/2 poin
Value of equity $1,537.50 4. Math errors: -1/2 point each
+ Exercise proceeds from options $100.00
Value of equity with exercise proceeds $1,637.50
/ Number of shares + Options $110.00
Value per share $14.89
Problem 2
All Retail ET Luxury Retai Online Retail ETF
EV/Sales 0.90 2.25 7.50
After-tax operating margin (next year) 6.00% 16.00% NA
Sales/Capital Ratio 2.00 1.25 6.00
Expected growth rate in operating incom 3.00% 3.00% NA
Expected Return on Capital = 12.00% 20.00%
a. Cost of capital for typical retail firm

EV/Sales = AT Op Mgn (1- Reinv Rate)/(Cost of capital -g) 1. Did not compute return on capital: -1 poi
Return on capital for retail = 12.00% 2. Error on reinvestment rate: -1/2 to -1 poin
Reinvestment Rate = 25.00% 3. Error on solving for cost of capital: -1/2 t
EV/Sales = 0.90 = (.06*(1-.25))/(r -.03)
Solving for r = cost of capital = 8.00%
b. Solving for intrinsic EV/Sales for Luxury Retail

Reinvestment Rate = 15.00% 1. Did not compute return on capital: -1 poi
Cost of capital for Luxury Retail = 10.00% 2. Error on reinvestment rate: -1/2 to -1 poin
EV/Sales = 1.94285714 3. Error on solving forEV/Sales: -1/2 to -1 p
Actual EV/Sales = 15.81% ! Overvalued by 15.81%
c. Solving for revenue growth for online retail ETF

Actual EV/Sales = 7.50 1. Error on input: -1/2 point each
Cost of capital for online retail = 12.00% 2. Math error: -1/2 poiny
EV/Sales = 1.80 + 25 (Expected Revenue growth ) - 15 (Cost of capital)
7.50 = 1.80+ 25(X) - 15 (.12)
Solve for X,
Expected revenue growth rate = 30%
Problem 3
Entertainment
Movie Theaters
Travel Services
Company
Revenues $400 $300 $300 $1,000
Operating Income (next year) $100 $30 $50 $180
Effective tax rate 36% 20% 36% 33.33%
After-tax Operating Income (next year) $64 $24 $32 $120
Invested Capital $500 $400 $100 $1,000
Expected Growth Rate 3.00% 3.00% 3.00% 3.00% Part a.
Cost of capital 10.00% 8.00% 7.00% 9.00% 1. Error on return on capital: -1 point
2. Error on reinvestment rate: -1/2 to -1 poin
Parts a & b
Return on capital 12.80% 6.00% 32.00% 12.00% Part b
Reinvestment Rate 23.44% 50.00% 9.38% 25.00% 1. Error on return on capital: -1 point
Value $700.00 $240.00 $725.00 $1,500.00 2. Error on reinvestment rate: -1/2 to -1 poin
Value of consolidated company = $1,500.00 3. Error on summing the parts: -1/2 to -1 po
Value of sum of the parts $1,665.00
Part c Part c
The combined company has a less optimized capital structure than that the individual units
All or could have.
nothing
The operating income, taxes and growth rate that we are using is just the sum of the divisonal values and thus
the change in value cannot be because of improved efficiency, lower taxes or higher growth. The only number
where there is potential variation is the cost of capital.
Problem 4
StreamTV DigiMovies DigiStream (combined) Part a.
Revenues $1,000.00 $800.00 $1,800.00 1. Error on return on capital: -1 point
Pre-tax operating income $100.00 $60.00 $150.00 2. Error on reinvestment rate: -1/2 to -1 poin
Effective tax rate 40.00% 20.00% 20% Part b.
Invested capital $800.00 $400.00 $1,200.00 1. Error on operating income: -1 point
Expected growth rate 2% 2% 5% 2. Error on taxes: -1/2 point
Cost of capital 10% 10% 10% 3. Error on reinvestment: -1 point
4. Error on return on capital in year 5: -1 po
Return on capital 7.65% 12.24% 5. Error on valuation: -1/2 to -1 point
Reinvestment Rate 26.14% 16.34% 6. Error on calculating synergy value: -1 po
Reinvestment $15.69 $7.84
Value of Business $565.00 $512.00 $1,077.00
Part b
Base 1 2 3 4 5
Operating Income $150.00 $157.50 $165.38 $173.64 $182.33 $191.44
Effective tax rate 20% 20% 20% 20% 20% 20%
After-tax Operating Income 120 126 132.3 138.915 145.86075 153.153788
- Reinvestment $23.53 $24.00 $24.48 $24.97 $25.47 $25.98
FCFF $102.00 $107.82 $113.95 $120.39 $127.18
$1,621.49
Invested capital 1200 $1,224.00 $1,248.48 $1,273.45 $1,298.92 $1,324.90
After-tax return on capital 10.50% 10.81% 11.13% 11.45% 11.79%
Reinvestment Rate 16.96%
Present Value at 10% $92.73 $89.11 $85.61 $82.23 $1,085.78
Value of combined firm $1,435.45
- Upfront cost of moving to Singapore $150.00
- Value of standalone firms $1,077.00
Value of synergy $208.45
I computed return on capital based on invested capital at the end of the prior year, but if you used the current year'
Problem 5
Part a. Part a
S= 450 Any input that is wrong: -1/2 point
K= 500
T= 12.00
Standard deviation = 30%
Cost of delay (if any) = 8.33% ! Iused 1/n, but I was lenient and gave a lot of leeway on this input.
Part b
i. Redix has limited access to capital, unpredictable reinvestment needs and earns a return on capita
There is no value to the option if you have unlimited accesss to capital or if your projects don't earn more than the cost of capital.
Part c
Value of Zee TV = $1,500.00 1. Any input error: -1/2 point each
Value of expansion option 2. Error on Black Scholes: -1 point
S = Value of expanding today = $1,500.00 d1 = 1.06824247 3. Error on computing value of deal: -1 poin
K = Cost of expanding today = $1,000.00 N(d1) = 0.85729442
t= 5
Standard deviation = 40% d2 = 0.17381527
Risk free rate = 3% N(d2) = 0.56899468
Value of option = $796.20
Value of Zee TV with expansion option $2,296.20

Cost of acquisition = $2,250.00
Value added by deal $46.20
ormalize earnings correctly: -1 point
ecompute ROIC: -1 point
se reinvestment rate: -1 point
value for minority holding in RigWorks: -1 point

djust for options correctly: -1 point
dd cash/ subtract debt: -1/2 point each
ompute return on capital: -1 point

reinvestment rate: -1/2 to -1 point
solving for cost of capital: -1/2 to -1 point
ompute return on capital: -1 point

solving forEV/Sales: -1/2 to -1 point
nput: -1/2 point each

return on capital: -1 point

summing the parts: -1/2 to -1 point

operating income: -1 point

axes: -1/2 point
reinvestment: -1 point
return on capital in year 5: -1 point
valuation: -1/2 to -1 point
calculating synergy value: -1 point
u used the current year's invested capital, I still gave full credit.
hat is wrong: -1/2 point
way on this input.
Part b
All or nothing
Part c
t error: -1/2 point each
Black Scholes: -1 point
computing value of deal: -1 point
Problem 1
a. Expected cash flows
Invested Capital = 120
Return on invested capital = 12.50%
Expected growth rate = 15%
Reinvestment rate = 120%
Cost of capital (next 5 years) 9%
Most recent 1 2 3 4 5
After-tax operating income $15.00 $17.25 $19.84 $22.81 $26.24 $30.17
- Reinvestment $20.70 $23.81 $27.38 $31.48 $36.20
FCFF -$3.45 -$3.97 -$4.56 -$5.25 -$6.03
PV at 9% -$3.17 -$3.34 -$3.52 -$3.72 -$3.92
Value of FCFF (next 5 years) -$17.67
b. Imputed ROIC forever
Value of equity today = $268.50
+ Debt $45.00
- Cash $15.00
Enterprise value today $298.50
- Value of FCFF (from part a) -$17.67
Value of terminal value today $316.17
Future value of terminal value= $486.46
Value of terminal value = 486.46 = 30.17 (1.025) (1-.025/.125)/(X - .025)
Solving for X,
Cost of capital in perpetuity = 7.59%
Problem 2
Average:
Current 1981-2013
Forward PE 20 12
Return on equity 15% 12%
Expected nominal growth (in per 3% 4%
T.Bond rate = 3% 5%
a. Normalized ERP
PE = (1- g/ ROE)/ (Cost of equity -g) g/ ROE = Payout ratio
12 = (1-..04/.12)/(Cost of equity-.04)
Cost of equity = 9.56%
Equity Risk Premium = 4.56%
b. Implied ERP
Fair PE today = 17.56
Actual PE = 20.00
Stocks are over priced -13.89%
c. Breakeven growth
PE = 20 = (1-g/.15)/(.0756-g) ! The payout ratio will change as the growth rate changes
Solving for g,
Expected growth rate = 3.83%
Problem 3
EBIT (1-t) ROC Growth rate Reinvestment FCFF Cost of capitaValue
Alcoholic Beverages $10.00 5.00% 2% 40.00% $6.00 7% $120.00
Restaurants $60.00 20% 2% 10.00% $54.00 8% $900.00
Corporate -$9.00 1.50% -$9.00 7.50% -$150.00
Intrinsic value of company $870.00
Post-divestiture
Alcoholic Beverages $10.00 5.00% 0% 0.00% $10.00 7% $142.86

Restaurants $60.00 20% 3.33% 16.67% $50.00 8% $1,071.43
Corporate -$4.50 1.50% -$4.50 7.50% -$75.00
Intrinsic value of company $1,139.29
Problem 4
Delta
Applianc CafeCoz Combined company
es
Revenues $100.00 $25.00 $125.00
After-tax operating
$10.00 $5.00 $15.00
Unlevered beta for
income
0.8 0.8 0.8
sector
Debt/Capital ratio 20.00% 0.00% 20.00%
Invested Capital $100.00 $25.00 $125.00
Return on capital 10.00% 20.00% 12.00%
Expected growth rate = 3.00% 3.00% 3.00%
Reinvestment Rate 30.0% 15.00% 25.00%
Levered Beta = 0.92 2.00 0.92
Cost of equity 7.60% 13.00% 7.60%
Cost of capital 6.68% 0.13 6.68%
Value of business $190.22 $42.50 $305.71
Value added from $115.49
Price paid on
acquisitoin = $85.00
acquisition
Value added= $30.49
(destroyed) =
Value of Delta, post-
acquisition = $220.71
Problem 5
a. DCF value of equity
DCF value of assets = 800 If you have a going concern, the liquidity discounts on the assets are irrelevant.
- Market value of debt 600 Market value of debt
Value of equity (DCF)
= 200
=
b. Probability of default
Face value of debt = 1000
PV of face value @
riskfree rate = 888.487048
Market value of debt = 600
Probability of default = 32.47% Probability over 4 years
Annual probability (not
needed) = 7.28%
c. Equity as a
liquidation
Stock Price=option $712.50 T.Bond rate= 3.00%
Strike Price= ### Variance= 0.250000
Expiration (in years) = 4 Annualized dividend 0.00%
d1 = 0.281025
N(d1) = 0.610654
d2 = -0.71898
N(d2) = 0.236078
Value of equity as a call = $225.71

Grading Template
! Return on capital incorrect: -1 point

! Cash flow computed incorrectly: -1 point
! Did not add back net debt: -1 point

! Did not take future value: -1 point
( Need it for next part)
! Did not compute reinvestment rate: -1 point

! Error on solving for g: -1 point
I Did not set up PE equation correctly: -1 point

! Did not use payout ratio: -1 point
! Did not subtract risk free rate: -1/2 point

! Did not update cost of equity: -1 point

! Did not solve for growth rate: -1 point
! Used company's cost of capital for divisions: -1 point
! Did not compute reinvestment rate: -1 point
! Did not compute corporate costs: -1 point
! Did not reestimate reinvestment rate for restaurants: -1 points

! Did not recompute corporate costs: -1 point
! Did not revalue alcoholic beverages with zero growth: -1 point
Part a.
Did not compute cost of capital for Delta correctly: -1 point
Did not compute reinvestment rate: -1 point
Part b.
Did not compute cost of capital for CafeCoz correctly: -1 point
Did not compute reinvestment rate: -1 point
Part c.
Did not net out price paid to CafeCoz: -1 point
Did not revalue combined company correctly: -1 point
! All or nothing
! Solved for YTM: -1/2 point
! All other mistakes: -1 point

! Any input wrong: -1 point
! Option value wrong, given inputs: -1 to -2 points
Problem 1
Last year 2 years ago 3 years ago 4 years ago 5 years ago
Revenues $1,000 $980 $950 $920 $900
After-tax Operating Income -$120 $325 $330 -$80 $250
After-tax operating margin -12.00% 33.16% 34.74% -8.70% 27.78%
Revenues 1000 1. Error on computing normalized operating income: -1 point

Normalized margin 15.00% 2. Did not recompute normalized ROiC: -1 point
Normalized operating income 150 3. Error on reinvestment rate: -1/2 point
Normalized ROIC 0.125 4. Other math errors: -1/2 point each
Normalized reinvestment rate = 20% (If you use aggregate margin, you will get 14.82% as normalized value)
Value of operating assets = 2460 1. Did not add cash: -1/2 point
+ Cash 150 2. Did not add minority holding: -1/2 point
- Debt 500
+ Minority holding 290 ! Since the problem was worded ambiguously, I gave full credit if you added .1(290) = 29
Value of equity 2400
Probability of nationalization 20%

Expected proceeds 1200 1. Did not estimate expected proceeds correctly: -1 point
+ Cash 150 2. Did not factor in probability into value: -1 point
- Debt 500 3. Math errors: -1/2 point each
+ Minority holdings 290
Valeu of equity 1140 ( I did give full credit if you assumed that you would get $1200 as your proceeds from
nationalization and did not factor in the debt & cash)
Expected value 2148
Problem 2
Brand Name Generic
EV/Sales 1.4 0.6
Generic Companies
EV/Sales 0.6 ! Did not set up equation for EV/Sales: -1 point
After-tax margin 4% 2. Did not compute reinvestment: -1 point
Expected growth rate = 3% 3. Math error: -1/2 point
Return on capital = 0.12
Reinvestment Rate 0.25
EV/Sales = After-tax margin (1- Reinvestment Rate)/ (Cost of captial -g)
0.60 = 0.04 (1-.25)/ (Cost of capital -.03)
Cost of capital 8.00%
Brand name companies

EV/Sales 1.4 ! Did not set up equation for EV/Sales: -1 point
Let the after-tax margin be X 2. Did not compute reinvestment: -1 point
Return on capital = 3X ! ROC = Sales to capital * Margin 3. Math error: -1/2 point
Cost of capital = 8%
1.4 = After-tax margin (1-3/3X)/(.08-.03)
After-tax margin = 8%
New after-tax margin = 8% ! I know! I screwed up! ! Did not set up equation for EV/Sales: -1 point
Sales/Capital Ratio = 3.45 (Same margin as before) 2. Did not compute new return on capital: -1 point
New Return on capital = 0.276 3. Math error: -1/2 point
Reinvestment rate = 0.10869565
EV/Sales ratio = 1.4261
Problem 3
Zuma Alta
After-tax Operating Income $100.00 R$ 50.00
Invested Capital $800.00 R$ 250.00
Cost of equity 9% 16%
After-tax cost of debt 3% 6%
Debt ratio 40% 20%
Expected growth 2.5% 6%
ROIC 0.125 0.2 1. Used wrong currency discount rate: -1 point

Cost of capital 6.600% 14.000% 2. Used wrong company & wrong currency: -2 point
Reinvestment rate 0.2 0.3 3. Error on reinvestment rate: -1/2 point
Value of operating assets $1,951.22 R$ 437.50 4. Did not convert to US$: -1/2 point
In US$ terms $1,951.22 $218.75 5. Error on conversion: -1/2 point
Value of combined firm $2,169.97
After the merger

Zuma Alta (in US$) Combined With synergy
After-tax Operating Income $100.00 $25.00 $125.00 $135.00 1. Error on combined firm's operating incom
Invested Capital $800.00 $125.00 $925.00 $900.00 2. Error on compbined firm's cost of capital:
Cost of equity 9.50% 3. Error on reinvestment rate: -1/2 point
After-tax cost of debt 3.50% 4. Error on computing synergy value: -1/2 p
Debt ratio 40%
Cost of capital 7.100%
ROIC 13.51% 15.00%

Expected growth rate 3%
Reinvestment rate = 20.0%
Value of operating assets $2,634.15
Value of synergy $464.18
Problem 4
EBIT (1-t) Book equity Book debt Cost of capitaExpected growROIC Reinvestment
Steel $100.00 $600.00 $200.00 8% 2.50% 12.50% 20%
Chemicals $50.00 $400.00 $100.00 10% 2.00% 10.00% 20%
Real Estate $60.00 $600.00 $600.00 8% 3.00% 5.00% 60%
Value of company
Divestiture proceeds = $900.00

EBIT (1-t) Invested capitROC Expected gro ReinvestmentValue
Steel $156.25 $1,250.00 12.50% 2.50% 0.2 $2,272.73
Chemicals $95.00 $950.00 10.00% 2.00% 0.2 $950.00
$3,222.73
New value of the firm = $3,222.73
Problem 5
1 2 3 4 5 Beyond
FCFF -$100.00 -$50.00 $50.00 $75.00 $100.00 Grows 3% forever
Cost of capital 15% 15% 15% 15% 15% 10%
$1,471.43
Value today = -$86.96 -$37.81 $32.88 $42.88 $781.28
Value of business = $732.27
+ Cash from VC 150 ! Since the cash will be held by the firm, the post money value = Value of business + Cash
Overall value $882.27
% of firm to VC 17.00%
Option to double holding Option to abandon holding

Type of option Call Type Put
S= $150.00 S= $150.00
K= $150.00 K= 75
t= 4 t= 4
r= 3% r= 3%
Standard deviation = 30% Std dev 30%
d1 = 0.50 N(d1) = 0.6915 d1 = 1.6552 N(d1) =

d2 = -0.10 N(d2) = 0.4602 d2 = 1.0552 N(d2) =
Value of option = $42.50 Value of opti $2.35

ou added .1(290) = 29
your proceeds from
for EV/Sales: -1 point

stment: -1 point
combined firm's operating income: -1 point
compbined firm's cost of capital: -1 point
reinvestment rate: -1/2 point
computing synergy value: -1/2 point
Value of operating assets

$1,454.55 1. Di dnto compute reinvestment rate: -1 point
$500.00 2. Error on ROIC estimate: -1/2 point
$480.00 3. Error on valuation: -1 point
$2,434.55
1. Did not estimate divestiture proceeds: -1/2 point

2. Did not compute value added by investments: -1 point
3. Error on reinvestments & value: -1/2 point
1. Error on discounting: -1 point
2. Did not add cash to PV: -1 point
alue of business + Cash
1.Inputs wrong for call option: -1 point

2. Inputs for the put option: -1 point
3. Call option value wrong: -1 point
4. Put option value wrong: -1 point
0.9511
0.8543
Problem 1 Note
High Growth Stable Growth If you compute your ROC without netting out cash,
Expected growth rate (next 3 years ) = 20% 3% it will be 12%. You should still get full credit if
Return on invested capital = 15% 15% everything else is based on 12%. The final value per
Reinvestment rate = 133.33% 20.0% share should be about $5.81.
1 2 3 Term year
EBIT (1 -t) $72.00 $86.40 $103.68 $106.79
- Reinvestment $96.00 $115.20 $138.24 $21.36
FCFF -$24.00 -$28.80 -$34.56 $85.43
Terminal value $1,220.46
Cost of capital 12% 11% 10% 10%
Cumulative cost of capital 1.1200 1.2432 1.36752
Present value -$21.43 -$23.17 $867.19
Value of operatng assets $822.60
+ Cash $100.00
- Debt $200.00
Value of equity $722.60
+ Exercise proceeds from options $100.00 ! Even though the strike price> stock price, it is < intrinsic value per share.
/ Number of shares (with options) 120.00 ! Add the options outstanding
Problem 2
Pre-tax operating margin for retail = 10%
EV/Sales ratio for retail = 0.85
EV for retail business = 425
- Debt 105
Equity value of retail business 320
Return on equity of financial arm 20%

PBV ratio of financial arm = 1.6
Equity value of financial arm = 160
Equity value of company = 480 ! 320 + 160

Number of shares outstanding = 50
Value per share = $9.60
Part b
Intrinsic value of equity = 480
Book value of equity = 400
PBV ratio = 1.2
ROE for company = 0.125

Expected growth rate = 0.03
1.20 = (0.125 -.03)/ (Cost of equity - .03)

Cost of equity = 10.92% ! Should get full credit if you put in (1+g) and got 11.15% instead
Problem 3
SmartCell LitCell
After-tax Operating Income next year $100.00 $15.00
Book value of equity $400.00 $100.00
Book value of debt $150.00 $0.00
Cash $50.00 $0.00
Number of shares 100 5
Cost of capital 9% 10%
Part a
SmartCell LitCell Combined
Return on invested capital 20% 15%
Reinvestment Rate 15.00% 20.00%
Value of operating assets $1,416.67 $171.43 1588.09524
+ Cash $50.00 $0.00
- Debt $150.00 $0.00
Value of equity $1,316.67 $171.43
Intrinsic value/share $13.17 $34.29
Exchange Ratio = 2.60397830018 ! Offer 2.60 shares of SmartCell shares for every LitCell share
Part b
Invested capital in combined firm = 600
Return on capital for combined firm = 20% Notes
After-tax operating income = 120 The key in this part of the problem is to recognize that both
Reinvestment rate = 15.00% companies' values will be affected by the presence of synergy.
Cost of capital 9% You cannot just adjust just the acquiring company's value (for
Value of operating assets, with synergy $1,700.00 of the synergy) or the target company's value (for it's share). O
Value of operating assets, no synergy $1,588.10 give away that you are not doing both is if your value per shar
Value of synergy = $111.90 for either company remains unchanged from part a. Note that
both company's share values go up after you introduce synerg
LitCell's portion of synergy = $67.14
LitCell's intrinsic value of equity = $171.43
Total value of equity (with synergy) = $238.57
LitCell's value per share = $47.71
SmartCell's intrinsic value of equity = $1,316.67

SmartCell's portion of synergy = $44.76
Total value of equity (with synergy) = $1,361.43
SmartCell's value per share = $13.61
Exchange ratio = 3.50472193075 ! Offer 3.506 shares of SmartCell shares for every LitCell share
Problem 4
Packaged Goods Toiletries Combined firm
Invested Capital $600.00 $900.00 $1,500.00
After-tax Operating Income next year= $66.00 $54.00 $120.00
Part a
Return on capital for company = 8.00%
Cost of capital for the company

Debt for company $1,200.00
Market value of equity = $300.00
After-tax cost of debt = 5.40%
Debt to capital ratio = 80.00%
Cost of capital = 8.3200%
Value of the firm = $1,424.05

- Debt $1,200.00
Value of equity = $224.05
Note
The solution is unrealistic in keeping equity value pe
Part b when the firm divests itself of the toiletries division.
New cost of capital like there is no choice, there is an adjustment that c
Levered beta before change = 3.00 ! (20%-2%)/6% the value per share. Remember that the divestiture
D/E ratio before change = 4 The present value of the cash flows from the toiletri
Unlevered beta = 0.88235294118 based upon the old cost of capital was: 54(1-.02/.06
The value of equity should therefore increase by $30
Debt after change = 900 make the share price $3.30 (330/100). While no one
D/E ratio after change = 3.00 ! Left equity unchanged considered giving extra credit, if you did.)
Levered beta after change = 2.47058823529
Cost of equity after change = 16.82%
After-tax cost of debt after change = 4.20%
Debt to capital ratio = 75.00%
Invested capital in packaged goods 900

Return on capital on packaged goods 0.11
After-tax operating income = 99 ! Keeping return on capital at 11% on this business
- Debt $900.00
Part c
Stock price today = Status quo value (1- prob of change) + Optimal value (Prob of management change)
3.00 = 2.24 (1-X) + 6.12 (X)
Solving for X,
Probability of management change 19.59%
Problem 5
a. Value the rental building based on rental income
Expected rental income next year = 4800000
After-tax rental income = 2880000
Expected growth rate in perpetuity = 2%
Value of rental property = 48000000
b. Value of the option to expand

Rental Income from expansion (annual) 4000000
After-tax rental income 2400000
S = PV of rental income = 40000000 ! If you used treated $40 million as after-tax income, I still gave full cred
K = Cost of expansion today = 50000000
t= 20
Riskless rate = 3%
Cost of delay = 6% ! This is a debatable question. While you don't lose any of the life of your rental property by wai
up the cash flow, once building becomes viable. Note, though, that since the cost of delay is not
of the option life, you cannot fall back on 1/n. If you assume that there is no cost of delay, becau
anything by waiting, I think you have a reasonable argument. I therefore gave full credit for a no
Value of underlying asset = ### Riskfree rate = 3.00%
Strike price = ### Variance= 0.09
Life of the option 20 Annualized dividend 6.00%
d1 = 0.05728541
N(d1) = 0.52284108
d2 = -1.2843554
N(d2) = 0.09950882
Value of the option to expand = $3,568,488.37 ! Without a cost of delay, the value of the option is $23.6 million and
you should full credit for that answer.
Total value of building = $51,568,488.37 ! Add to value from part a
Grading guidelines
C without netting out cash, Part a
d still get full credit if 1. Error on reinvestment rate: -1 point
n 12%. The final value per 2. Other math errors: -0.5 point each
Part b
Did not recompute reinvestment rate: -1 point
Math errors: -0.5 point each
Part c
Did not use cumulated WACC:-1 point
Did not do exercise value adjustment: -1 point
insic value per share.
1. Did not subtract out all debt to get to equity value for retail: -1/2 point
2. Used wrong book value to get equity value for financial: -1 point
3. Subtracted out debt from financial equity value: -1 point
! Used book value of equity for whole firm (not just fin svces): -1/2 point
1. Did not adjust net income for reinvestment: -1 point

2. Did not compute ROE correctly: -1 point
3. Other math errors: -0.5 point each
1. Did not compute reinvestment for either firm: -1 point
2. Did not compute ROC correctly: -1 point
3. Did not adjust SmartCell equity value for debt &cash: -1 point
1. Did not adjust operating income: -1 point

blem is to recognize that both 2. Did not adjust reinvestment rate: -1 point
cted by the presence of synergy. 3. Did not allocate synergy to both firms: -1 point
e acquiring company's value (for it's share
ompany's value (for it's share). One
oing both is if your value per share
nchanged from part a. Note that
go up after you introduce synergy.
Did not compute reinvestment: -1 point
Cost of capital incorrect: -1 point
Other math errors: -1/2 point each
alistic in keeping equity value per share at $3 in part b,

sts itself of the toiletries division. While it looks
ce, there is an adjustment that could have been made to
. Remember that the divestiture brought in $ 600 mill! Did not reestimate cost of equity: -1 point
f the cash flows from the toiletries division to the c ! Did not recompute income: -1 point
cost of capital was: 54(1-.02/.06)/(.0832-.02)=$570. ! Reinvestment rate wrong: -1 point
should therefore increase by $30 milllion, which would
ce $3.30 (330/100). While no one in the class tried this, I would have
xtra credit, if you did.)
All or nothing
Math errors: -1/2 point
! Error on any input: -1 point

! Error on option value: -1 point
-tax income, I still gave full credit. Your S = $66.67 million in that case
ny of the life of your rental property by waiting, you do give

, though, that since the cost of delay is not a function
assume that there is no cost of delay, because you don't lose
gument. I therefore gave full credit for a no cost of delay answer.
he option is $23.6 million and
Problem 1
Part a.
After-tax operating income/ closed store = 0.06
Latest year 1 2 3 4 5
Revenues $500.00 $450.00 $400.00 $350.00 $300.00 $250.00
After-tax Operating Income $15.00 $14.40 $13.80 $13.20 $12.60 $12.00
- Reinvestment -$20.00 -$20.00 -$20.00 -$20.00 -$20.00
FCFF $34.40 $33.80 $33.20 $32.60 $32.00
# Stores 100 90 80 70 60 50
Capital Invested $200.00 $180.00 $160.00 $140.00 $120.00 $100.00
Return on capital 7.50% 8.00% 8.63% 9.43% 10.50% 12.00%
Part b
Expected growth in perpetuity = 3%
Reinvestment rate in stable growth = 25.00% ! 3%/12%
Cost of capital in stable growth = 8.00%
After-tax Operating income in year 6 = $12.36
Terminal Value = $185.40
Part c
Value of the going concern.
Operating cash flows $34.40 $33.80 $33.20 $32.60 $32.00
Terminal Value $185.40
PV @ 10% $31.27 $27.93 $24.94 $22.27 $134.99
Value of the firm as going concern = $241.40
Average book value of capital over next $140.00

Value as liquidated concern = $70.00 ! Igave you full credit even if you used starting or ending book value instead.
Probability of default 30%
Expected value = $189.98
Problem 2
For the three business with EV multiples
Estimated value of Steel business = 600 ! Used equity value as enterprise value for f
Estimated value of technology business 1250 ! Did not allocate net debt correctly: -1 poin
Estimated value of chemical business = 250 ! Other errors: -0.5 point each
Total enterprise value of non-financial b 2100
- Estimated net debt for non-financial s 500 ! See below for allocation of net debt
Value of equity in non-financial busines 1600
+ Value of equity in financial business 600
Value of equity in the company = 2200
Value per share = 22
Allocation of net debt

Net Debt = Debt - Cash = 1000
Business Net Interest Proportion Net debt held
Steel 20 20.00% 200
Technology 10 10.00% 100
Chemicals 20 20.00% 200
Financial Service 50 50.00% 500
Entire company 100 100.00% 1000
Part b
Market value of equity = $2,500.00 ! Error in backing out EV for steel: -1 point
+ Net Debt for company = $1,000.00 ! Error in computing imputed ROC: -0.5 po
Enterprise value for firm = $3,500.00
- Enterprise value of technology $1,250.00
- Enterprise value of chemicals $250.00
- Enterprise value of financial services $1,100.00
Breakeven Enterprise value for steel $900.00
EV/EBITDA multiple 9
Breakeven return on capital = 20.00% ! 3.0 + 30(.2) = 9
Problem 3
Part a
After-tax operating income = $15.00 ! Did not compute reinvestment: -1 point
Return on capital = 10.00% ! Other errors: -1/2 point each
Value as stand alone firm = 180.25
Part b
Debt ratio at optimal = 20% ! Used acquirer's debt ratio and/or cost of debt: -1 point
After-tax cost of debt at optimal = 3% ! Did not relever beta at new debt ratio: -1 point
Beta at optimal = 1.15 ! Computed value of control incorrectly: -1 point
Cost of equity at optimal = 9.7500%
Cost of capital at optimal = 8.400%
Value at new cost of capital = $200.28
Value of control = $20.03
Part c
Depreciation with new book value = $15.00 ! Did not compute tax benefit correctly: -1 point
Depreciation with old book value = $12.50 ! Other errors: -1/2 point each
Incremental depreciation = $2.50
Tax savings from depreciation = $1.00
PV of incremental depreciation = $6.59 ! Discounted at Dellwood's cost of capital
Problem 4
a. Status Quo Value High growth Stable growth ! Did not compute current reinvestment rate correctly: -1 point
Reinvestment rate = 0.75 25.00% ! Did not adjust reinvestment rate in terminal value: -1 point
Return on capital = 8.00% 8.00% ! Other errors: -1/2 point each
Expected growth rate for next 5 years = 6% 2%
1 2 3 4 5 Term year
After-tax Operating income 21.2 22.472 23.82032 25.2495392 26.7645116 27.2998018
- Reinvestment 15.9 16.854 17.86524 18.9371544 20.0733837 6.82495045
FCFF 5.3 5.618 5.95508 6.3123848 6.69112789 20.4748513
Terminal value 255.935642
Present value 4.81818182 4.64297521 4.47413974 4.31144375 163.070561
Value of operating assets today 181.317302
Value per share = 18.1317302 ! 10 million shares outstanding
b. Optimal value
Reinvestment rate = 20% ! Used 2% growth rate with 20% RIR and 12% ROC (not consistent): -
Return on capital = 12% ! Did not consider the effect on number of shares: -1/2 point to -1 point
New Cost of capital = 9%
Expected growth rate in perpetuity = 2.400%
Value of the operating assets = 248.242424
- Debt $120.00
Value of equity in firm = $128.24
/ Number of shares outstanding = 3.38176783 ! I am assuming buyback at old stock price of $18.13 but that is unrealistic. See
Value of equity per share = $37.92 below for a more realistic estimate… But I wll full give you full credit.
If you want a fairer assessment, here is what you would need to do

Increase in firm value from change of co $66.93
Increase in value per share = $6.69
New value per share = $24.82
Number of shares bought back 4.83398438
Number of shares remaining = 5.16601563
Value per remaining share = $24.82
Problem 5
a. The monopolist.
The cost of holding off on exercising the option will be greater if you are in a competitive business. Your cost of delay will not be 1/12 but
1/Number of years before a competitor develops a product. That will lower the option value.
b. If gold prices go up and volatility decreases. The increase in price will make more reserves viable. The decrease in volatility will reduce the
option value and thus make it more likely that the reserves will be developed. (The will be worth more as developed DCFs than undeveloped options)
c. Companies that earn high excess returns (you need that for the project to have value) and unpredictable reinvestment needs (which increases the
option value of holding that excess debt capacity)
d.
S = Value of the assets = 40 ! Option inputs wrong: -1/2 point each
K = Face value of payments on debt = 60 ! Option value wrong: -1 point
t = Duration of the debt = 5 ! Made wrong judgment on whether to buy or not: -1/2 point
Riskless rate = 2%
Standard deviation in firm value = 30%
Value of call option (equity )

d1 = -0.12
N(d1) 0.4523
d2= -0.7908
N(d2) 0.2145
Value of equtiy = 6.44674243
Value of debt = 33.5532576

Face value = 60
Imputed interest rate on debt = 12.33%
Actual interest rate on debt = 11%
Don't buy the bonds. You are not earning a high enough rate.
! Reinvestment not computed correctly: -1 point
! Revenues not correct: --1/2 point
! Operating income incorrect: -1/2 point
! Return on capital in stable growth incorrect: -0.5 to -1 point

! Did not use right cost of capital: -1/2 point
! Other errors: -1/2 point
! PV computed incorrectly: -1/2 point

! Wrong discount rate used: -1/2 point
! Did not use book value in liquidation value: -1 point
y value as enterprise value for financial service firm: -1 point

ocate net debt correctly: -1 point
rs: -0.5 point each
cking out EV for steel: -1 point
mputing imputed ROC: -0.5 point
of debt: -1 point
rate correctly: -1 point

minal value: -1 point
nd 12% ROC (not consistent): -1/2 point
of shares: -1/2 point to -1 point
l not be 1/12 but
ility will reduce the

than undeveloped options)
eds (which increases the
buy or not: -1/2 point

Problem 1
Current 1 2 3 4 5 6
EBIT (1-t) $10.00 $11.00 $12.10 $13.31 $14.64 $16.11 $16.59
- Reinvestment $5.50 $6.05 $6.66 $7.32 $8.05 $4.15
= FCFF $5.50 $6.05 $6.66 $7.32 $8.05 $12.44
Terminal value $248.82
PV of FCFF (VC) $5.03 $5.07 $5.10 $5.14 $165.05
Value of Firm (Equity) toVC $185.40
Probability of failure 20.00%
Value of equity $0.00 ! Al alternative interpretation is that the equity is worth CF over first 5 years ($25.52). Full credit
Value of equity today = $148.32
! Did not compute new reinvestm
Reinvestment rate - first 5 years 50.00% ! Current ROC = 20%; Expected growth = 10% ! Used wrong cost of equity: -1 po
Reinvestment rate - Stable 25.00% ! New ROC =12%; New g =3%
Cost of capital - Stable 8% ! Used unlevered beta for sector (IPO)
c. VC Total Beta = 1.25 ! Discounted at wrong cost of equ

Cost of equity (capital) 9.2500% ! Did not adjust for distress: -1 po
Value of equity today = $148.32 ! See above ! Forgot CFs for next 5 years: -0.5
Problem 2
Start with the median grocery store
After-tax operating margin = 0.03 ! Half the ma ! Errors on margin or ROC: -1 point ! Wrong cost of capital = -1 point
Sales/Capital ratio 3 ! 1.5 the sales to capital ratio of Trader Jack's ! Other errors: -0.5 point each
Return on capital = 9% Math errors: -0.5 point Math errors: -0.5 point
EV/Sales ratio = 0.4 !
Therefore, cost of capital = 0.08 ! 0.4 = 0.03 (1-.3333)/(r -.03)
Now try Trader Jack's
After-tax operating margin 6% ! 180/300
Capital invested = $150.00 ! After tax operating income/ ROC
Sales to capital ratio = 2 ! Sales/Capital invested
Return on capital = 0.12
EV/Sales ratio = 0.9
Part b.
EV/Sales for LW = 1.25
Now assume that the margin drops to 4.5% and revenues increase by 10% ! Did not adjust EV/Sales ratio =
For value to be unchanged, new EV/Sales ratio = 1.13636364 ! Wrong margin = 0.5 point
Plug into the regression equation and solve for g ! Math errors: -0.5 point
1.1364 = 0.35 + 15 (g) + 7.5 (.045)
New growth rate = 2.99%
Problem 3
Keiko Matterhorn Combined firm
EBIT (1-t) expected next year 100 80
Revenues 1000 1250 ! Errors on indiviual company valuations: -1 point
Book Capital invested 1000 1000 ! Math errors: -0.5 point
Expected growth 3% 3%
Return on capital = 0.1 0.08

Reinvestment Rate = 30% 38%
Value today = 1166.66667 833.333333 2000
$ Reinvestment 30 30 120
Combined firm
Reinvestment rate = 0.66666667 ! Wrong reinvestment rate: -1 point
Return on capital = 12% ! Math errors: -0.5 point
Bse year EBIT 174.757282 ! I took the 3% growth out. I gave you full credit even if you used 180.
1 2 3 4 Term year
EBIT (1-t) $188.74 $203.84 $220.14 $237.76 $244.89
- Reinvestment $125.83 $135.89 $146.76 $158.50 $61.22
FCFF $62.91 $67.95 $73.38 $79.25 $183.67
Present value $57.72 $57.19 $56.66 $2,224.70
Value of firm today = $2,396.27
Value with no synergy = $2,000.00
Value of synergy = $396.27 ! If you use 180 in year 1, synergy value = 285
Problem 4
Return on capital now = 0.06
Reinvestment rate now = 0.5 ! Wrong ROC or reinvestment rate: -1 point
Cost of equity now = 20.3200%
After-tax cost of debt now= 0.072
Cost of capital now = 0.09824
Value today = 351.699883
Unlevered beta = 0.8 ! Did not adjust beta correctly: -1 point

New levered beta = 1.28
New cost of equity = 11.6800%
New cost of debt = 0.048
New cost of capital = 0.0824
New operating income = 72 ! ROC on existing assets rises

Reinvestment rate = 0.33333333 ! Did not adjsut current operating income: -1 point
New firm value = 916.030534 ! Did not adjust reinvestment rate = -0.5 point
Expected firm value = 577.432143

Value of debt = 400 ! Did not adjust for probability of change: -1 point
Value of equity = 177.432143
An alternative solution
Value of equity with existing manag 0 ! Since value of firm (352) < Debt
Value of equity with new manageme 516.030534
Expected value of equity = 206.412214
Problem 5
S = Liquidation value = 120 ! EV*EBITDA = 150 million; in liquidation, you lose another 20%
K = Face value of debt = 200
t = Weighted duration = 7
r =Long term Tbond rate = 4% ! Error on liquidation value = -1 point
Standard deviation in firm value = 30% ! Firm value, not equity value Error on weighted duration = =0.5 point
Error on standard devaition = -0.5 point
Valeu of equity as an option
N(d1) 0.5422
N(d2) 0.2458
Value of the call = 27.91 ! All or nothing, given your inputs
Value of debt = 92.09
Interest rate on debt = 0.1172
Default probability = 75.42% ! 1 - N(d2) ! All or nothing, given your output
Default spread = 0.0772 ! Interest rate on debt - riskfree rate
! No reinvestment : -1.5 points
! Wrong reinvestment: -1 point
t 5 years ($25.52). Full credit
! Did not compute new reinvestment rate: -1 point

! Used wrong cost of equity: -1 point
! Discounted at wrong cost of equity: -1 point

! Did not adjust for distress: -1 point
! Forgot CFs for next 5 years: -0.5 point
! Wrong cost of capital = -1 point

! Other errors: -0.5 point each
Math errors: -0.5 point
! Did not adjust EV/Sales ratio = -1

! Wrong margin = 0.5 point
! Math errors: -0.5 point
Problem 1
Current 1 2 3 Term year
EBIT (1-t) $80.00 $68.00 $61.20 $58.14 $59.88
- Reinvestment -$102.00 -$61.20 -$29.07 $17.97
FCFF $170.00 $122.40 $87.21 $41.92
Terminal value $598.84
Cost of capital $0.12 $0.11 $0.10
Cumulated cost of capital $1.12 $1.24 $1.37
PV $151.79 $98.46 $501.68
Reinvestment rate -150.00% -100.00% -50.00% 30.00% 1 g/ ROC

(When g is negative,
reinvestment rate is negative)
Growth rate -15% -10% -5% 3%
Capital invested 800

Return on capital 10.00%
Value of firm = $751.92

+ Cash $50.00
- Debt $100.00
Equity $701.92
Problem 2 Current 1 2 3
Revenues 500 600 700 800
Net Income 50 72 98 128
PE = 4.5 + 80 (Revenue growth - next 3 years) + 40 (Net Profit margin)
Current values
Revenue growth = 16.96% ! I gave full credit, if you used arithmetic avera
Net Profit Margin 10.00% margin over three years (13-14%), which yields
PE = 22.07
Equity value today = 1103.42838
/ Number of shares 100
To earn 25% as the return each year ! Scaling up PE ratio will not work since earnin
Required return = 25% ! Failed to compute equity value in three years:
Expected value per share = 21.5513356 ! Failed to compute margin in year 3: -1/2 to -1
Equity value in 3 years = 2155.13356
PE ratio = 16.8369809
Net Profit margin in 3 years = 0.16
Imputed growth rate = 7.42%
Problem 3
Hardware Software
EBIT (1-t) 50 50 ! Errors in computing reinvestment rate: -1 poin
Book value of capital 1000 400 ! Math errors: -1/2 point
Expected growth rate 3% 3%
Return on capital 0.05 0.125
Reinvestment rate 60.00% 24.00%
Value of the firm 343.333333 559.142857 902.47619
a. If you stopped new investments in the hardware business

Reinvestment rate 0% ! Used growth rate even as reinvestment goes to
Growth rate 0% ! Other errors: -1/2 to -1 point
Value 555.555556
Current value 343.333333
Increase in value 212.222222
b. If you were able to double your reinvestment rate in the software business
Reinvestment rate for next 3 years = 48.00% ! Used 6% as the growth rate forever: -1 point
Expected growth rate for next 3 years = 6.00% ! Other errors: -1/2 to -1 point
1 2 3 Term year
EBIT (1-t) 53 56.18
59.5508 61.337324
Reinvestment 25.44 26.9664
28.584384 14.7209578
FCFF 27.56 29.2136
30.966416 46.6163662
PV 25.0545455 24.1434711 523.602183
Value = 572.800199
Current value = 559.142857
Increase in value = 13.6573421
Problem 4
Flava Inca Combined firm
Market value of equtiy 800 800 ! EBIT of combined firm incorrect: -1 point
Maket value of debt 200 200 ! New growth rate not computed: -1 point
Cost of equity 9% 9% ! Cost of equity not recomputed: -1.5 point
After-tax cost of debt 4% 4% ! Other errors: -1/2 to -1 point each
Expected growth rate = 2% 2%
Return on capital 10% 10%
Tax rate 40% 40%
Equity ratio = 0.8 0.8
Cost of capital = 8.000% 8.000%
Current FCFF 60 60
Current EBIT (1-t) 75 75
EBIT (1-t) of combined firm 150

Reinvestment rate 20.0%
Return on capital 12%
Expected growth rate 2.400%
Unlevered beta 0.86956522
New cost of equity 9.47%
New cost of capital = 0.07826087
Value of firm 2264.61538
Value of synergy 264.615385
Problem 5
After-tax operating income 15 ! Math errors: -1 point
Reinvestment rate 0.2
Cost of caital 11%
Growth rate 3%
Value of firm 150
Stock Price= $150.00 Annualized continuous risk 4.00%

Strike Price= $250.00 Variance= 0.09
Expiration (in years) = 5 Annualized dividend yield 0.00%
d1 = -0.12794129 ! Option inputs incorrect: -1 point

N(d1) = 0.44909772 ! Option value incorrect: -1 point
! Option misidentified as a put: -1 point
d2 = -0.79876168
N(d2) = 0.21221431
Value of the call = $23.93 ! Added value instead of subtracting: -1 point

The government owns this call.
Your firm value = $126.07 ! 150 - 34.67
probability of nationalization 21.22% ! N(d2)

! Did not compute reinvestment right: -1 point
! Did not compute new reinvestment rate for stable growth: -1 point
! Did not compute cumulated cost of capital: -1 point
t rate is negative)
! Did not add cash and subtract debt: -1 point
credit, if you used arithmetic average growth rare (20%) and the average
three years (13-14%), which yields a higher PE ratio.
PE ratio will not work since earnings are changing.

ompute equity value in three years: -2 points
ompute margin in year 3: -1/2 to -1 point
omputing reinvestment rate: -1 point

wth rate even as reinvestment goes to zero: -1 point
rs: -1/2 to -1 point
s the growth rate forever: -1 point

rs: -1/2 to -1 point
incorrect: -1 point
mputed: -1 point
mputed: -1.5 point
Problem 1
1 2 3 4 5
Revenues $50 $175 $350 $575 $700
Operating income -$6.00 -$2.00 $3.00 $25.00 $70.00
a.
Operating income -$6.00 -$2.00 $3.00 $25.00 $70.00
NOL at end of year $11.00 $13.00 $10.00 $0.00 $0.00
Taxes $0.00 $0.00 $0.00 $6.00 $28.00
EBIT (1-t) -$6.00 -$2.00 $3.00 $19.00 $42.00
Reinvestment $12.50 $31.33 $43.67 $56.25 $31.25
FCFF -$18.50 -$33.33 -$40.67 -$37.25 $10.75
PV -$15.55 -$23.53 -$24.14 -$18.58 $4.50
b. Total beta = 3.00

c. Terminal value computatiion

EBIT (1-t) in year 6 = $43.26
FCFF in year 6 = $34.61
Cost of capital (stable) = 10.00% ! As furn is public, market beta prevails
Terminal value = $494.40
d. Value today
PV of FCFF = -$77.29
PV of terminal value = $207.18
Value of operating assets = $129.89
+ Cash $10.00
Value of firm (equity) $139.89
Problem 2
Expected growth rate after year 5 = 4%
Expected EBITDA/Sales in year 5 = 12.50%
Expected EV/EBITDA in 5 years = 6
Expected EBITDA in year 5 = 500
Expected EV in year 5 = 3000
EV today (based on expected EV) - 1702.28057
- Debt today 1000
+ Cash today 250
Value of equity today = 952.280567
Actual equity value today = 200
Probability of dstress = 79.00% ! You get 44% if you use enterprise value…
Problem 3
Business EBIT (1-t) Expected growCost of capitaBook Capital Reinvestment
Retailing 60 3% 9% 400 20.00%
Hospitality 30 4% 10% 300 40.00%
Transportation 36 2% 8% 600 33.33%
Value of operating assets of the firm =
Value of operating assets = $1,500

+ Cash $100
- Debt $600
Value of equity = $1,000
Value per share $10
b.
Divestiture proceeds = 400 ! Equal to value in last section
If invested in retailing
Business EBIT (1-t) Growth rate Cost of capitaBook Capital Reinvstment
Retailing 120 3% 9% 800 20%
Hospitality 30 0.04 0.1 300 0.4
Net value
+ Cash $100.00
- Debt $600.00
Value of equity $1,400.00
$14.00
c.
Business EBIT (1-t) Growth rate Cost of capitaBook Capital Reinvstment
Retailing 60 3% 8% 400 20%
Hospitality 30 0.04 9% 300 0.4
Net value

+ Cash $100.00
- Debt $600.00
New # of shares = 60.00 ! Bought back 400/10 = 40 million shares
Prroblem 4
Status Quo Optimal Man Comments
EBIT (1-t) next year 80 100 Cost cutting pays off
ROC on new investment 8% 10% Better investment choices
Expected growth rate 4% 4% Still a mature firm
Cost of capital 9% 9% Firm will remain all equity funded
a. Effect of management change
Reinvestment rate = 50.0% 40.0%
Value of firm = 800 1200
Value of firm and equity should increase by $ 400 million
b.
Value of non-voting shares = 32 ! Status quo value/ # voting + # non-voting)
Voting share price = 38.4
Premium comanded by voting shares = 6.4
Expected value of control = 64
Probabilty of management change = 16.00%
c.
PV of expected control = $308.87 ! PV of 400 discounted back 3 years
Premium per share = $30.89 Since acquired, 100% probability of change
Price per voting share - $62.89
Problem 5
S = PV of expected cash flows from introducing software today = $226.01
K = Cost of developing software today = $500.00
t = Period over which you can make the expansion decision = 5
Standard deviation = Standard deviation of database companies = 50%
Riskless rate = 3% ! Match riskfree rate to life of option
Value of the option = $56.30

d1 = -0.0171 N(d1) = 0.4932
d2 = -1.1351 N(d2) = 0.1282
! You cannoy use Reinv rate = g/ ROC because you have
negative operating income and shifting ROC….
1. Did not computed taxes right: -1 point

2. Reinvestment wrong or ignored: -1.5 point
! Total beta incorrect: -0.5 to -1 point

Math errors: -0.5 point
! Forgot reinvestment rate: - 1point

! Forgot taxes: -0.5 point
! Used total beta instead of market beta: -1 point
When the firm goes public, you have to switch to a market beta
! Did not compute PV: -1 point

Ignored cash: - 0.5 point
( The firm will be privately held for the next 5 years and then for an IPO>
The cash flows and terminal value have to be discounted at 19%)
! If you compute the probabilities based on Enterprise value, you are making
a dangerous assumption, i.e., the proceeds from liquidating assets in the event of
distress is zero. It is much better to assume that equity will be worth zero in distress, i.e.
that the distress sale proceeds will be less than the debt outstanding.
Used EV instead of equity value to compute probabilities: -1 point

Computed EV/EBITDA in year 5 right, but then got lost: -1 to -2 points
Tried to compute EV/EBITDA today: -2 to -3 points (it will get you nowhere)
enterprise value…
Value of firm
800 ! No need to use (1+g), since you alaredy have next year's EBIT
300 ! Forgot reinvestment rate in valuation: -1 point
400 ! Did not subtract debt and add cash: -1 point
1500
Value
1600
300
1900
! Divested busines and got capital back instead of fair value: -1 point
! Errors on computing new value for retailing: -0.5 to -1 point
Value
960 ! Did not revalue businesses: -1 point
360 Compued number of shares wrong: -1 point
1320
0 million shares
ng + # non-voting) ! Computed non-voting share value incorrectly: -1 point

! Set up for control value incorrrectly: -1 point
! There is a more precise way to answer this questioin, which is to forecast
bability of change FCFF with statuq quo numbers for the next 3 years and then estimate the terminal value with
optimal numbers. That yields a value per share of about $ 56.
You cannot just discount the optimal value of 1200 back 3 years (yield 926) and then
subtract out today's status quo value of 800.
! Wrong value for S: -1 point

! Any other wrong input: -0.5 points each
! Match riskfree rate to life of option
! I was very generous and accepted any value within 25% of the right answer, given your inputs
Problem 1
EBIT (1-t) = 20
Cap Ex = 8
Depreciation = 4
Chg in WC = 1
Acquisition = 5
Total Reinvestment = 10 ! Acquisitions are part of reinvestment
Reinvestment Rate = 50.00% ! 10/20
Return on capital = 20% ! 20/(40+60)
Expected growth = 10.0%
Current 1 2 3 4
EBIT (1-t) $20.00 $22.00 $24.20 $26.62 $29.28
- Reinvestment $10.00 $11.00 $12.10 $13.31 $14.64
= FCFF $10.00 $11.00 $12.10 $13.31 $14.64
Terminal Value
PV AT 10% $10.00 $10.00 $10.00 $10.00
After year 5
Return on capital = 12%
EBIT (1-t) in year 6 = 33.498608 ! 32.21*1.04
Terminal Value $372.21
Value of operating assets = $281.11
+ Cash $0.00
- Debt = $40.00
Value of Equity $241.11
Problem 2
PE = 20 = 2 + 2.5 X - 5 (1.20)
Solving for X,
Expected growth rate - 9.60%
In year 5.
Expected growth rate= 4%
Beta = 1
Forecated PE = 7 ! 2 + 2.5*4-5*1
Forecasted EPS = $0.9489 ! 0.60*1.096^5
Forecasted price = $6.6420
Problem 3
Firm Value = 100 ! 20*2 + 60
100 = 16 (1- .04/ROC)/ (.12-.04)
Solving for ROC
b. Pay down debt option

If you assume that the write down of capital has no impact on future ROC
Reinvestmnet rate = 50.00% ! g/ ROC = 4/8
New firm value = 133.333333
If you assume that changes in the current ROC will also affect future ROC
Old capital = 200 ! EBIT (1-t)/ Old ROC
New capital = 160 ! Sold off idle assets and reduced capital
New ROC = 10.00% ! 16/160
New Reinvestment rate= 40.00% ! g/ ROC
Firm Value = 160
c. Redeploy capital
New EBIT (1-t) = 25
Capital = 200
New ROC = 0.125
New Reinvestment rate = 0.32
Firm Value = 212.5
Problem 4
FCFF next year = 10
For private firm

Total Beta = 2
FCFF next year = 10
Acquisition price = $166.67

Acquisition value = $238.10 ! Once you acquire private firm, its cost of equity = 8.2%
Value created = $71.43
Existing value = $238.10
New Value = $309.52
New Depreciation = 30
Old Depreciation = 20
Increase in depreciation = 10
Tax savings = 4 ! Multiply by tax rate
PV over 5 years = 15.8870069 ! Discount at cost of equity of public firm
Problem 5
After=tax cash flow = 200
PV over 10 years = 1130.04461
Investment = 1500
NPV = -369.955394
Option inputs
S= 1130.04461
K= 1500
t= 15
Riskless rate = 4%
Cost of delay = 0% if you assume that the project life will not be truncated if the project is
0.1 !if you assume that the project life will be truncated if the project is tak
0.17698416 ! If you assume truncation and base the cost of delayo n cashflows lost
Value of the option

With no cost of delay $596 million ! Rounding off will yield about $592 million
With 10% cost of delay $38 million
With 17.7% cost of delay $2 million
Grading Guideline
1. Did not include acquisition = -1 point
2. Other errors: -0.5 point to -1 point
5 1. Did not do cashflows = -1 point

$32.21
$16.11
$16.11
$372.21
$241.11
1. Did not adjust reinvstment = -1 point
1. Did not compute new PE = -2 points

2. Did not compute expected EPS = -1 point
1. Return on capital incorrect = -1 point

1. Ignored reinvestment = -1 point
1. Ignored reinvestment = -1 point

2. Failed to adjust ROC = -1 point
1. Errors in valuation = -1 point
1. Failed to use total beta = -1 point
1. Failed to see value increase = -1 point

of equity = 8.2%
1. Used wrong tax savings = -1 point

2. Used wrong discount rate = -1 point
1. Errors in NPV = -1 point

1. Each error on input = -1 point
2. Cost of delay of 1/15 = -1 point
3. Error on option value (given inputs) = -1 to -2 points
(Depending on how far you are off…)
ot be truncated if the project is taken after year 5

be truncated if the project is taken after year 5
cost of delayo n cashflows lost
Problem 1
a. Estimating FCFF
EBIT (1-t) 1500
- Net Cap ex 600 ! Cap ex (1000) - Depreciation (400)
- Change in WC 150
FCFF 750
b.
Return on capital = 20.00% ! 1500/ (5000 + 2500)
Expected growth rate= 10.0%
c.
Levered beta = 1.15
Unlevered beta = 1.00
Levered beta for private firm= 1.15
Correlation with market= 0.4
Levered total beta = 2.875
After-tax cost of debt= 4.20%
Cost of capital = 14.04% ! 16.5%(.8)+4.2%(.2)
Debt to capital = 20%
Problem 2
a. Return on equity = 16%
Expected growth rate= 12%
Payut ratio = 25.00%
Year Net Income Dividends
1 224 56
2 250.88 62.72
3 280.9856 70.2464
b. Rxpeccted growth rate = 4%

Expected ROE = 12%
Payout ratio = 66.67%
Expected dividend in year 4 = $194.82 ! 380.99*1.04*.66667
Terminal value of equity = $3,896.33 ! 194.82/(.09-.04)
c. Value of equity today = $3,167.09

+ Exericse procceeds = 250 ! 25*10
Total $3,417.09
/ Number of shares + options 110
Value per share= $31.06
Problem 3
a. P/BV = 1.80 = (ROE -g)/ (Cost of equity -g) = (.2-.05)/(Cost of equity - .05)
Solving for the cost of equity
Cost of equity for mature firm = 9.00%
Emerging market premium= 4.33%
b. Predicted P/BV = 1.7 ! 0.9+ 0.06*20-.4
Actual P/BV = 1.8
Stock is overvalued slightly
c. Current retention ratio = 25.00% You can solve this problem by just assumiing that the book value of equi
Expected retention ratio (first 3 years) 50.00% Estimate the earnings and dividend for the high growth phase.
Expected growth rate in first 3 years = 10.00% ! Cannot be f I was very, very generous and gave you fully credit, if you tried….
Price to Book ratio = 2.01 ! Two stage DDM

High growth: g=10%, Payout =50%, k=13.33%
Stabel grwoth = 5%, Payout = 75%, k = 13.33%
Problem 4
Acquiring Firm Target
Combined
firm firm (after merger)
Revenues 1500 1000 2500
EBIT (1-t) next year 150 75 250
Cost of capital 8% 10% 9%
Return on capital 12% 10% 14%
Expected growth 3% 3% 4%
Reinvestment Rate = 25.00% 30.00% 28.57%
FCFF 112.5 52.5 178.571429
Value of the firm = 2250 750 3571.42857
Value of Synergy = 571.428571
b. If you have to wait years,

Valeu of synergy = 371.389364 ! 571.43/1.09^5
c. Additional depreciable base = $100.00

Depreciation per year = $20.00
Tax savngs each year = $8.00
PV o tax savings = $31.12 ! PV OF $ 8 mil at 9% for 5 years
Problem 5
S= 7.5 ! 15 % of firm value today
K= 10
t= 5.00
Riskless rate = 0.05
y = Dividend yield = 0% ! You lose nothing by waiting.
b. Valuing the option

d1 = 0.525
d2 -0.593
N(d1) = 0.7
N(d2) = 0.28
Value of the call = $3.10
c. I would reject the venture capitalist's offer.
He is paying $10
He is receiving $10.60 ! 15% of firm value today + Option value
You are giving up more than you are getting. I know all the rationalizations - you really need the money, your estimate could be wrong…- but the bottom
you should negotiate for a better deal.
miing that the book value of equity = $1
he high growth phase.
fully credit, if you tried….
ould be wrong…- but the bottom line is that
Problem 1
1 2 3 Terminal year
EBIT (1-t) $99.00 $108.90 $119.79 $124.58 ! 10% first 3 years, 4% thereafter
- Reinvestment $49.50 $54.45 $59.90 41.5272 !50% reinvestment first 3 years, 33.33% thereafter
FCFF $49.50 $54.45 $59.90 $83.05
Terminal value = 1384.24 ! Terminal CF/(.10-.04)

PV $44.20 $43.41 1027.90677 ! Discount back at 12%
Value today = $1,115.51
+ Cash 100 1. Reinvestment rate wrong for part a: -0.5 point
- Debt 150 2. Forgot to after-tax cashflows: -0.5 point
- Eq Options 50 3. Did not compute reinvestment rate anew for stable growth: -1 poiint
Value of equity $1,015.51 4. Discounted terminal value at 10% instead of 12%: -0.5 points
Value per share= $50.78 5. Miscalculated option value: -0.5 point
6. Other errors: -0.5 pointt each
Problem 2
a. Intrinsic Price to Book Ratio
Return on equity = 8% Easest way to do this
Cost of equity = 6% PBV = (ROE - g)/ (Cost of equity -g)
Growth rate = 2%
Payout ratio = 75.00%
Price to Book = 1.5
b. If price to book ratio is 3

PBV = 3 = (ROE -.02)/(.06-.02)
Implied ROE = 14%
c. ii. Katsunaka has a lower proportion of bad real estate loans in its portfolio than the typical bank
(Makes it less risky). All of the other choices would lead to a lower Price to book
d. iii. It will increase the price to book ratio

(Both the market value of equity and the book value of equity will decrease by the same
absolute amount. The ratio will go up in this case, because the company has a price to book that exceeds one)
Problem 3
Current ROC = 8% 1. Did not compute reinvestment rate: -1 point
Current reinvestment rate = 0.5 2. Other errors: -0.5 point each
Value of firm = $1,386.67
- Debt $250.00
+ Cash $100.00
Value of equity $1,236.67
b. After divestiture
Capital= $1,000.00 When you sell the division for book value, you will receive $ 1,000 which
EBIT (1-t) = $96.00 adds to your cash balance.
ROC = 0.096 If you assume that the buyer of the division will also assume the debt, you
Reinvestment rate = 0.41666667 will need to reduce the proceeds by the debt. Thus, if half the debt is assumed
Value of firm = $970.67 by the acquirer, he will pay you only $875 million. The net effect on your value per share
- Debt $250.00 is zero.
+ $1,100.00 1. Failed to compute new ROC and reinvestment rate; -1 point
Value of equity $1,820.67 2. Did not account for proceeds from divestiture correctly: -1 point
Value per share $18.21 c. Other errors: -0.5 point each
Problem 4
Acquirer Target Combined
EBIT (1-t) 50 10 60 A very common error was using the market value of the two firms as th
Cost of equity 9% 9% 9% If you use this approach, you will get the wrong ROCs for the firms (U
Growth rate 4% 4% 4% will yield you values of $ 600 million and $ 80 million for the two firm
Implied reinvestment 25 2.5 13.75 of synergy is very close, but that is pure coincidence. Thus, if you feel
Market value 500 150 925 victimised for doing this (you lost 1.5 points), don't!
Value of synergy = 275
If Paris Media pays $250 million on the acquisition, it gets to keep $175 million in synergy gains
Value of equity after transaction = 675 ! 500 + 150 + 275-250 ! Tried to back into value per share from combined firm:
Value per share = 13.5 2. Forgot the value of the target firm (considered only syn
Problem 5
a. DCf value = 200
b. Option inputs
S = Value of firm = 200 1. Used $ 400 million instead of $ 200 million; it is the only expansion
K = Cost of expansion = 250 the original investment: -1 poin5
Standard deviation = 30% 2. Wrong exercise price: -1 point
Riskless rate = 5%
Time to option expiration = 5 If you have the inputs rights and get anywhere between $50 and $60 mi
get full credit. If you doubled the S, the value you should get for the op
d1 = 0.37544543 d2 = -0.29537497
N(d1) = 0.64633539 N(d2) = 0.38385373
growth: -1 poiint
n your value per share

rket value of the two firms as the book value.
e wrong ROCs for the firms (Using those ROCs
nd $ 80 million for the two firms. The resulting value
coincidence. Thus, if you feel
per share from combined firm: -1 point (you cannot get there)
target firm (considered only synergy: -0.5 to -1 point
million; it is the only expansion that is the option, not
ywhere between $50 and $60 million for the option value, you should
value you should get for the option is about $220 million.
Problem 1
Year 1 2 3 4
EBIT (1-t) $100.00 $115.00 $132.25 $152.09 Sundry errors: -1 each
FCFF $25.00 $28.75 $33.06 $38.02

Growth Rate = 15.00%
Return on capital = 20.00%
EBIT (1-t) in year 5 = $158.17 Forgot to recalculate reinve

Reinvestment Rate in year 5 = 20.00% Other errors: -0.5 each
Terminal value = 1581.71
Value of operating assets today ### Forgot to discount cashflow

+ Cash 100 Forgot to discount terminal
- Debt 150
Value of Equity ###
Per Share Value $20.96
Problem 2
Estimated value of telecomm equipment = 1200 Got value of telecomm equi
Estimated value of cable business = 1200 Got value of cable business
Total Value of operating assets of firm = 2400 Too weighted average of tw
+ Cash 600
- Debt 1000
Value of Equity = 2000
Per Share Value = 20
Estimated value of parent telecomm equip 900

Estimated value of cable business = 1200
Value of parent company operating assets 2100
+ Cash 450
- Debt 900
Value of parent company equity = 1650
+ Value of 60% of LiveTel equity = 210
Value of MiniTel Equity = 1860
Value of equity per share = 18.6
Value of LiveTel operating assets = 300

+ Cash 150
- Debt 100
Value of LivTel Equity = 350
Altenatively,
Value of Equity from consolidated statement = 2000
- 40% of LiveTel Equity Value (Minority interest MV) 140
Value per share = 18.6
Problem 3
a. Value of firm = 1040
1040 = 180 (1.04) (1- .04/ROC)/ (.10-.04)
Sovling for ROC
b. Unlevered beta = 1.25

New cost of equity = ###
New cost of capital = 9.40%
c. New return on capital = 12.00%

Existing reinvestment rate = 66.67%
Growth rate for next 3 years = ###
Growth rate after 3 years = 4%

Reinvestment rate after 3 years= 33.33%
If you double the return on capital, you will double the operating income to 360 million
Year 1 2 3 Term Year
EBIT(1-t) 388.8 419.904 453.496 471.636 ! If retunr on capital on exis
Reinvestment 259.2 279.936 302.331 157.212 (Alternatively, you can use
FCFF 129.6 139.968 151.165 314.424
PV 118.464 116.948 4562.48
Value of firm = 4797.9
Problem 4
Bandai Pac-Man No Syner Synergy
EBIT (1-t) 100 50 150 160 ! Note the increase in opera
Reinvestment Rate 0.25 0.3 0.2
FCFF 75 35 128
Cost of capital 9% 9% 9%
Growth Rate 3% 3% 3%
Value 1287.5 600.833 1888.33 2197.33
Capital invested 833.333 500 1333.33 1333.33
Value of Synergy = 309
Problem 5
Value of 20% share of current value = 4 ! There is no cost of delay h
To value the put option to sell back the 20% for $ 2 million
S = 0.2* Current value of firm = 4
K = Price at which you can sell back 20% 2
t= 2 ! Errors on option valuation
Riskless rate = 4% ! Errors on inputs: -1 point
Value of put option = $0.13
To value the call option to buy an additional 20%
S = 0.2* Current value of firm = 4
K = Guaranteed price = 6
t= 2
Riskless rate = 4%
Sundry errors: -1 each
Forgot to recalculate reinvestment rate: -1 point

Other errors: -0.5 each
Forgot to discount cashflows for first 4 years : -0.5 point

Forgot to discount terminal value: -0.5 point
Got value of telecomm equipment business wrong: -1

Got value of cable business wrong: -1
Too weighted average of two values instead of adding: -1
! If retunr on capital on existing investments doubles, the current operating income of 180 will also double to 360
(Alternatively, you can use a very high growth rate 9108%) in year 1 to reflect the improvement in return on existing as
! Note the increase in operating income in the base year to reflect the improvement in return on capital on existing asset
! There is no cost of delay here. You would wait until the very last moment to exercise these options.
! Errors on option valuation with inputs right: -1 point each

! Errors on inputs: -1 point each
o double to 360
n return on existing assets)
apital on existing assets to 12%

Problem Current 1 2 3 Terminal
Revenues 1000 1030 1060.9 1092.727 1125.50881
AT Op Mgn 3.00% 4% 5% 6% 6% ! Common errors
EBIT (1-t) $30.00 $41.20 $53.05 $65.56 $67.53 1. The margin changes each year, not the operating incom
+ Deprecn $20.00 $20.00 $20.00 $20.00 2. The net cap ex is a cash inflow, not an outflow (-0.5 to
- Cap Ex $15.00 $15.00 $15.00 $15.00 $20.26
FCFF $35.00 $46.20 $58.05 $70.56 $47.27
PV (@12%) $41.25 $46.27 $50.23
b. Terminal value = 47.27/(.10-.03) = $675.31 1. Used year 3 cashflow instead of computing new reinve
PV of terminal value = $480.67 ! Discount back at 12% 2. Used wrong cost of capital (12% instead of 10%) (-1)
c. Value today = $618.42 ! Discount terminal value back at 12%, not 10% (-0.5 to -
+ Cash $25.00 2. Add back cash, not subtract (-0.5)
- Debt = $150.00 3. Subtract out debt (-0.5)
Problem 2
After-tax operating margin for Springbok = 0.15 ! Mechanical errors (-0.5)
Expected EV/Sales = 0.25 + 0.10 (15) = 1.75
Value of Springbok = 175
b. Expected growth in revenues, since this is a firm value regression ! -1 for any other answer
c.
Value attached by the private equity investor to 33.33% equity = 40 ! 1. Added debt to 1/3 value (-0.5)
Value attached to all of the equity = 120 2. Mechanical errors (-0.5)
Value attached to the firm = 150
d.
Value of the firm in the 3 years = 211.75 ! Year 1 is 100 million… I did give full credit if you push
Value of the outstanding debt = 50 ! Forgot to subtract out debt (-1)
Value of equity = 161.75 Did not compute annual return (-0.5 to -1)
Annual return = (182.925/120)^(1/3)-1 = 10.46%
Problem 3
Value of the firm today = 100 ! Gave full credit even if you forgot the (1.03)
Value of firm = 15*(1-.03/ROC)*1.03/(.09-.03) ! Computed return on capital using market value of firm (-1.5 to -2)
Solving for the ROC
b. Value of firm at optimal debt ratio with return on capital = cost of capital
Reinvestment rate = 0.375 ! Interesting variations possible
Value of firm = 193.125 I did give full credit if you subtracted out new debt of 40%… and used 15 million sh
- Debt = 25 The two inputs are incompatible since moving to a 40% debt ratio will reduce the nu
Value of equity = 168.125
c. Value per non-voting share = $5.00

Value per voting share = $8.73 ! 5 + (168.125-75)/5…. I am assuming that voting stockholders get the entire value o
Problem 4
a. EV/BV ratio for Ludmilla = (.12-.04)/(.08-.04) = 2
Book value of Ludmilla = 500 ! If you use (1+g) in the equation, your book value is slig
PV of depreciation tax benefits on existing book value = 134.201628
New book value for Ludmilla = 1250 Common errors
PV of depreciation tax benefits on new book value = 335.50407 1. Depreciated market value of old firm rather than book
Value of synergy = 201.302442 2. Computed tax savings using (1-t) instead of t (-1)
3. Mistakes in present value calcualtion (-1/2 to -1)
b. If Lybov pays $1,250 million for Ludmilla, it has overpaid by about $49 million
Its value will decrease by $49 million
New value of Lybov = 1451.30244 ! Add synergy and subtract premium ! The change in stock price should reflect the difference b
- Debt 250 ! Subtract out debt The stock price prior to the change was $12.50…. The ne
Problem 5
a. PV of cashflows over next 20 years = 926.867782
NPV of project = -273.132218
b.
S= 926.867782 ! Used only first 10 years of cashflows (wh
K= 1200
t= 10 Used 20 years instead of 10 years
r= 4%
Std devn = 31.43%
Cost of delay 0.0431561 ! The loss of exclusivity seems to cost $40 million in after-tax cashflows each year
Value of the rights to this project = $177 million

ch year, not the operating income (-0.5 to -1)
h inflow, not an outflow (-0.5 to -1)
nstead of computing new reinvestment rate (-1)

ital (12% instead of 10%) (-1)
back at 12%, not 10% (-0.5 to -1)
I did give full credit if you pushed it out and extra year. The return would have been 15.1%.
return (-0.5 to -1)
40%… and used 15 million shares.

% debt ratio will reduce the number of shares outstanding.
ckholders get the entire value of control in this case…
quation, your book value is slightly smaller (483 million)
ue of old firm rather than book value (-2)

using (1-t) instead of t (-1)
ue calcualtion (-1/2 to -1)
e should reflect the difference between what was paid and what you get as synergy benefits
e change was $12.50…. The new stock price you compute should reflect the fact that they overpaid….
first 10 years of cashflows (why?)
ars instead of 10 years

Problem 1
Levered beta = 0.98 ! 0.80 (1+(1-.4)(150/400)) ! If you adjusted the beta for cash, you
Cost of equity = 0.0892 may run into consistency problems by a
Cost of capital = 7.80% you should not adjust betas for cash.
Part b
Return on capital = 0.125 ! I also gave full credit if you computed a non-cash ROC by netting
Part c
Expected after-tax operating income in year 4 = 69.212
Reinvestment rate in stable growth = 0.32 ! Reinvestment rate = g/ ROC = 4/12.5
Terminal value = 1239.71686
Part d
1 2 3
EBIT(1-t) $55.00 $60.50 $66.55
- Reinvestment $44.00 $48.40 $53.24
FCFF $11.00 $12.10 $13.31
$1,239.72
PV at 7.80% $10.20 $10.41 $1,000.34
+ Cash $50.00
- Debt $150.00
- Value of options = $120.00
Value of equity in common stock = $800.96
Value of equity per share = $16.02
Problem 2
EV/EBITDA of SoundTech = 8
8 = 7.5 - 2.4 tax rate + 6.5 (.20)

Tax rate = 33.33%
Part b
Actual EV/EBITDA = 7.50
Correct EV/EBITDA = 8.33
EV/EBITDA for Zif = 7.5 -2.4 (.40) + 6.5 (X) = 8.33 ! I also gave full credit if you used 8.25 (10% over 7.
Problem 3
a.
Unlevered beta = 0.75
Cost of equity = 0.092
Cost of capital= 7.44%
b.
EBIT (1-t) = 180
FCFF 83.2258065
Value of firm = 2516.12903
- Current value = 2000
Change in value = 516.129032 ! I took the short cut. If you decide to value the firm using existing ROC and rein
However, you are then assuming that the current problems would have lasted for
Problem 4
a. Total beta for Cavuto = 4
Cost of equity with Cavuto = 0.21
b. Total beta for Soros 2.25

Cost of equity for Soros = 0.14
Value of the firm = $35.36
c. Unlevered beta for combined firm = $1.07

Total beta = 2.14833091
Cost of Equity for combined firm = 0.13593324
Value of combined firm = $123.59
Value of Synergy = $39.28
Problem 5
Value of building = $85.00 ! Without expansion rights)
Value of expansion rights

S= 96.3333333 ! Discount back the PV of 102 one year at the cost of delay of 5.88%)
K= 125
r= 4%
t= 10
Cost of delay - 0.05882353 ! If you build the 25 floors today, you would be able to get the cashflow next yea
The cost of delay is not 1/10 since the project life is infinite…..
Value of expansion option = 5.79
! If you adjusted the beta for cash, you would have got a different answer but you
may run into consistency problems by adding cash back at the end. If you do the latter,
you should not adjust betas for cash.
you computed a non-cash ROC by netting out cash
ent rate = g/ ROC = 4/12.5
full credit if you used 8.25 (10% over 7.5. In reality, it is 7.5/0.9= 8.33)
alue the firm using existing ROC and reinvestment rate, the change in value would be much higher.
e current problems would have lasted forever if you had not come along as CEO.
at the cost of delay of 5.88%)
would be able to get the cashflow next year

roject life is infinite…..
Problem 1
Value of firm estimated by analyst = $3,000.00
Estimated FCFF next year = $150.00
Estimated EBIT (1-t) next year = $150.00
Book value of debt = $500.00
Book value of equity = $750.00
Correct value of firm = $1,750.00 ! If you backed into net income this year of $142.86,
your value would be $1,688 million.
Problem 2
Price to Book rati for Suntrust = 2.00
Price to book ratio for Southwest = 1.33
Price to book = (RoE -g)/ (Cost of equity -g)

Part a
(.2-.05)/(r -.05) = 2
Solving for r,
Cost of equity = 12.50% ! If you use P = Payout ratio (1+g)/ (r -g), you will get 12.88%
Part b
(ROE -g)/ (.125-.05) = 1.33
Solving for ROE, ROE = 15.00%
Problem 3
a. Valuing Nuevos Fashion
b. Valuing Fitch and Spitzer

c. Valuing combined firm

Operating margin of combined firm = 10%
New after-tax operating income = $325.00
Return on capital = 25% ! This is based upon the assumption that the firm will reduce capital invested.
Reinvestment rate = 20.00% If you assume that revenues will increase while capital remains unchanged, you
Value of combined firm = $5,460.00 will get an increase in value of $945 million.
Value of independent firms = $4,935.00
Value of synergy = $525.00
Problem 4
EBIT (1-t) = (EBITDA - DA) (1-t) = $75.00
Reinvestment = $50.00
Return on capital on existing investments = 6.00%
Current market value = $525.00
Cost of capital = 8.95% ! 525= 25 (1.04)/(r -.04)
Return on capital on new investments = 12.00%
New firm value = $1,050.00
Problem 5
a. NPV of project = -$148.64
b. NPV of small plant = -$74.32
c. Value of expansion option =

S = PV of cashflows from expanding today = $425.68
K = Cost of expanding today = $500.00
t= 5
Riskless rate = 6%
Cost of delay = 0.05 ! 1/n. Every year you wait, there are fewer years left in the investment.
Value of option = $102.61 The problem states that all you will have is the remaining life of the project. If th
Doing the project in two parts makes it a positive net present value investment.
reduce capital invested.
l remains unchanged, you
wer years left in the investment.
ve is the remaining life of the project. If this had not been stated, you could argue for a zero cost of delay.
Problem 1
Current 1 2 3 Terminal year
Revenues $1,000.00 $1,300.00 $1,690.00 $2,197.00 $2,284.88
EBITDA -$100.00 -$65.00 $84.50 $549.25 $571.22
Depreciation $100.00 $100.00 $100.00 $104.00
EBIT -$165.00 -$15.50 $449.25 $467.22
NOL Carryforward $330.50
Taxable income -$165.00 -$15.50 $118.75
Taxes $47.50 $186.89
EBIT(1-t) -$165.00 -$15.50 $401.75 $280.33
+ Depreciation $100.00 $100.00 $100.00 $104.00
- Cap Ex $50.00 $50.00 $50.00 $211.74
- Ch WC $15.00 $19.50 $25.35 $4.39
FCFF -$130.00 $15.00 $426.40 $168.20
EBITDA Margin -10.00% -5% 5% 25% 25%
NOL $150.00 $315.00 $330.50
PV -$116.07 $11.96 $2,298.85
Problem 2
PE = 13.5 ! 7.5 + 52.5 *.2 - 5* 0.9
Total beta = 2.25

PE = 6.75
Problem 3
Unlevered beta of Silverado Stores = 0.77 ! 1.20/(1+(1-.3)(80/100))
Unlevered beta of Zale Distributors = 1.05 ! 1.30/(1+(1-.3)(50/150))
Unlevered beta of combined firm = 0.92 ! 0.77 (180/380)+ 1.05 (200/380)
Levered beta of combined firm = 1.25
Value of synergy = $214.39 ! 10(1-.3)/(.0827-.05)

Note that $ 10 milion is next year's savings
Problem 4
Reinvestment rate = 60.00% ! G/ ROC = 3/5 = 60%
Value of Uvian = 50*(1-.5)(1-.6)(1.03)/(.08-.03) = $206.00
Unlevered beta = 0.75 ! Back out from cost of equity of 8%

Levered beta = 0.8625
Cost of equity = 0.0845
Cost of capital = 0.0748
New pre-tax return on capital = 20% ! (50*2)/ 500
New after-tax return on capital = 12%
Reinvestment rate = 25%
Value of Uvian = $1,034.60
Problem 5
Cost of capital = 5% + 1.4*4% = 0.106 ! Equal to cost of equity
Value of commercial product = $49.19
Value of patent
S= 88.2300754
K= 150
t= 15
r= 5%
Std dev = 40%
y= 0.06666667 ! Alternatively, 12/88.23
Value of patent = $12.57
Problem 1
PV of operating leases = 1000 (PVA,7%, 5 years) = $4,100.20
Imputed interest expense on operating leases = $287.01
Adjusted Operating income = 1000 + 287 + 1000 - 600= $1,687.00
After-tax Operating income (without tax benefit) = $1,012.20
If you considered the extra tax benefit of R&D being expensed,
Tax benefit from R&D expensing = (1000 - 600)*0.4 = $160.00
After-tax Operating income (with tax benefit) = $1,172.20
Book Value of Capital = BV of Debt + Operating leases + BV of Equity + Value of research asset = 1000 + 4100 + 5000 + 3000 =
Reinvestment rate = (Cap Ex - Depreciation+ R&D - Amortization of R&D)/ Adjusted EBIT(1-t) = 69.16%
Return on Capital = 1012/13100 = 7.73%

Cost of capital = 10.8% (.80) + 7% (1-.4) (.20) = 9.48%
EVA = (.0773-.0948) (13100) = -$229.25
Problem 2
a. Return on Capital = 2.5*20% = 50.00%
Reinvestment rate = 5%/50% = 10.00%
Value to Sales ratio = 0.20 *(1-.10) (1.05)/(.10-.05) = 3.78
b. Return on Capital = 3*8% = 24%

Reinvestment rate = 5%/24% = 0.20833333
Value to Sales ratio = 0.08*1.05*(1-.2083)/(.10.-5) = 1.33
c. Sales fro firm = 5000 *2.5 = $12,500

Brand name value = (3.78-1.33) (12500) = $30,624
Problem 3
a. Value of Existing product = 120 million (PVA, 8 years, 11%) = $617.53
b. Net present value of project = -2500 + 250 (PVA, 16 years, 11%) = -$655.21
c. Value of the patent
S = 1844.79
K = 2500
t = 16 years
y = 1/16 = 0.0625
Variance = 0.10
Value of the patent = 1844.79 e(-.0625*16) (.6368) - 2500 e (-.06*16) (.1841) = $256.00
Problem 4
Column1 TriMedia Leppard Combined firm
Cost of Equity 9.60% 10.400% 10.87%
Cost of Debt 4.20% 0.042 4.50%
Debt Ratio 10% 10% 30%
Cost of Capital 9.06% 9.78% 8.96%
Unlevered beta for TriMedia= 0.84375
Unlevered beta for Leppard = 1.03125
Weighted Unlevered Beta = 0.84375(1/3) + 1.03125(2/3) = 0.96875
Levered beta at 30% debt ratio = 1.21785714
FCFF next year for TriMedia : 1000 = X/(.0906-.05); Solve for X

FCFF next year = $40.60
FCFF next year for Leppard : 2000 = X/(.0978-.05)
FCFF next year = $95.60
Value of combined firm =(40.6+ 95.6)/(.0898-.05) = $3,439.39

Valeu of combined firm without synergy = $3,000.00
Value of Synergy = $439.39
0 + 5000 + 3000 = 13100
Problem 1
1 2 3 4 (Terminal year)
EBIT $100.00 $125.00 $156.25 $164.06
Net Cap Ex $ 30.00 $ 37.50 $ 46.50 $ 32.00
Total Working Capital $ 60.00 $ 70.00 $ 82.00 $ 88.00
Cost of Equity 12% 11% 11% 10%
Pre-tax Cost of borrowing 8.00% 7.50% 7% 7%
Debt Ratio 25% 25% 25% 25%
Cash Flows for next 3 years

1 2 3 Terminal year
Tax rate 0 16% 40% 40%
EBIT(1-t) 100 105 93.75 98.436
Net Cap Ex $ 30.00 $ 37.50 $ 46.50 $ 32.00
chg WC $ 8.00 $ 10.00 $ 12.00 $ 6.00
FCFF $ 62.00 $ 57.50 $ 35.25 $ 60.44
Cost of Equity 12% 11% 11% 10%

AT Cost of Debt 8% 6% 4% 4%
Cost of Capital 11.00% 9.83% 9.30% 8.55%
Terminal Value = 60.44/(.0855-.05) = $ 1,702
Value of firm = 62/1.11+77.50/(1.11*1.0983)+35.25/(1.11*1.0983*1.093)+1702/(1.11*1.09833*1.093) = $ 1,407.10
Problem 2
1 2 3 4
AHP $100 $120 $144 $173
HA $60 $69 $79 $91
Combined firm (with synergy) $172 $203 $239 $282
CF from synergy $12 $14 $16 $18
Value of AHP= $ 2,894.82

Value of HA = $ 1,542.37
Value of Combined firm= $ 4,745.66
Value of Synergy = $ 308.47
Problem 3
PE Ratio for the industry = 20 ! Based upon valuation of 2 billion and net income of 100
PEG Ratio for the industry = 2
PEG Ratio for Sysoft = 2.5 ! 1.25 times the industry average PEG ratio
PE ratio for Sysoft = 37.5
Value of Sysoft Equity= 3750
Problem 4
a. Value of firm = $ 15,000
PV of Cash flows from developed re $ 3,890
Value of undeveloped reserves = $ 11,110
a. Increase
b. Effect uncertain. Price increase is good, but variance drop is bad.
c. Effect uncertain. Increase in interest rates increases the value of the call, but the PV of oil will decrease as well (reducing S)
d. Decrease
Problem 5
a.ROC = 0.075 ! ROC = After tax margin* Capital turnove ratio = .03*2.5
Expected Growth Rate = 0.045 ! ROC * Reinvestment Rate
Value of firm 2280 ! = 300 (1-.6)(1.045)/(.10-.045)
b.
Restructured Return on Capital = 0.125
New growth rate = 0.05
Value of firm (restructured) = 4725 ! = 300 (1-.4)(1.05)/(.09-.05)
Change in firm value = 2445
If you assume that the improvement in margins increases oprating income from existing assets,
Restructured Return on Capital = 0.125
New growth rate = 0.05
Value of firm (restructured) = 7875 ! = 500 (1-.4)(1.05)/(.09-.05)
Change in firm value = 5595
Problem 1
Novotel VideoGraf
ROC 9.60% 0.1125
Reinv Rate 0.52083333 0.44444444
FCFF 46 150
Cost of Capital 9.52% 9.52%
Firm Value 1069.53056 3487.59965 $ 4,557.13
b. Value of Synergy
New ROC = (450+160)*.6/((1000+2400)*.8) = 13.46%
New Reinvestment Rate = 0.3715847
New Beta after restructuring = 0.9
New Cost of Equity = 0.1067
New Cost of Capital = 10.67% (0.75) + .08*0.6*.25 = 9.20%
New Value = 5746.57942
Value of Synergy = 5747 - (1070+3488) = $ 1,189.45
Problem 2
Solve for the FCFF used by the analyst
Value of firm prior to liquidity discount = 65/(1-.35) = 100
Cost of Capital used by analyst = 25% (.5) + 5% (.5) = 15%
FCFF used by analyst : 100 = FCFF (1.05)/(.15 - .05) = $ 9.52 ! $ 10 million if solving for next year's FCFF
Cost of Equity for firm = 5% + 1.1 (6.3%) = 11.93%

Cost of Capital for firm = 11.93% (.9) + 5% (.1) = 11.24%
Firm Value = 9.52 (1.05)/(.1124 - .05) = $ 160.33 ! No liquidity discount since firm is being sold to a
publicly traded firm with diversified stockholders
Problem 3
a. Talbot's: Low PE, High Growth, Low Risk, High Payout: Best of All Worlds
b. Abercombie: High PE, Low Growth, High Risk, Low Payout: Worst of all worlds
Problem 4
PBV = 0.5 = ROE * Payout ratio * (1+g)/(r -g)
g =4%; ROE = 8%
Payout ratio = 1 - g/ROE = 1 - .04/.08 = 50%
Solve for r which is the cost of equity
0.5 = .08*.5*(1.04)/(r - .04)
r = (0.08*.5*1.04+0.5*0.04)/0.5 = 0.1232
With the new return on equity of 16%
Payout ratio = 1- g/ROE = 1- .04/.16 = 0.75
New Price to Book Ratio= .16*0.75*1.04/(.1232-.04) = 1.5
This problem could have been solved even more quickly using PBV = (ROE -g)/(cost of Equity - g)
Problem 5
Value of the firm = 500
Value of developed assets = 30 (PVA,12%,10) = 169.506691
Value of option = $ 330.49
Let
S = PV of Cash flows from undeveloped product
K = S+150 ! Since net present value is -150
r = 5%
t = 15
y = Cost of Delay = 1/15
N(d1) = 0.75 ! N(d1) will always be higher than N(d2)
N(d2) = 0.60
Setting up,
330.49 = S exp (-1)* (.75) - (S+150) exp (-.10*15) (.6)
If you solve for S,
exp(-1) = 0.36787944
exp(-1.5) = 0.22313016
330.49 = S(.3679)(.75) - (S+150)(.4723)(.60)

S= $ 2,468.29 Thisis the present value of the expected cash flows
on if solving for next year's FCFF
ty discount since firm is being sold to a

ded firm with diversified stockholders
Problem 1
a. Estimated FCFF next year
EBIT (1-t) 252
- Reinvestment 100.8 ! Reinvestment Rate = g/ ROC = .05/.125 = .4
FCFF 151.2
Value of Firm = 151.2/ (.10 - .05) = 3024
b. Expected Tax Savings from NOL

1 2
EBIT 420 441
NOL Carry Forward 420 441
Taxable Income 0 0
Taxes $ 168.00 $ 176.40

PV of Savings $ 152.73 $ 145.79
Total PV of Savings = $ 298.51
Problem 2
Business Net Income
Book Value of Equity
Sector Reg ROE Expected
Expected
PBVMarket Value of Equity
Steel 150 1500 PBV = 0.8 + 10% 0.95 1425
Financial Services 300 2000 PBV = 1.3 + 15% 1.45 2900
Technology 100 500 PBV = 3.5 + 20% 4 2000
Retailing 200 1000 PBV = 1.75 + 20% 2.11 2110
8435
b. Effect of Divestiture
Value Effect of Divestiture = 2500 - 2000 = 500
Effect on value per share = 500/400 = $ 1.25
Problem 3
Expected Depreciation in year 4 = 10 (1.15)3 (1.05) = $ 13.98
Expected Capital Expenditures in year 4 = $15.97 (1.50) = $ 20.96
Expected Net Capital Expenditures in year 4 = $ 6.99
Expected present value of net capital expenditures in perpetuity = $ 85.16 ! [6.99/(.11-.05)]/1.113
New Estimate of Value = 400 - 97.3 = $ 314.84
Problem 4
S = PV of Cashflows on project = PV of $100 million growing 5% a year for 14 years = $ 802.10
Cost of Capital for Genzyme = 13.9%
K = Cost of taking project today = 1000
r = 5%
t = 14
Variance in firm value = Variance in Genzyme's firm value = 0.25
Dividend Yield = 1/14 = 7.14%
Problem 5
Merrill Lync Schwab Sum
No of Shares $ 330 $ 260
MV of Equity- before $ 21,450 $ 10,400
MV of Equity- after $ 20,790 $ 11,700
Synergy $ (660) $ 1,300 $ 640
b. Cashflow/(.10-.03) = 640
Solving for the cash flow,
Cash Flow = $ 44.80
Problem 6
Cost of Capital = (.105)(.8)+(.06)(.6)(.2) = 9.12%
Book value of equity at beginning of year = 300 - 25 = $ 275.00 ! Since no new equity issued, equity affected by retain
Book Value of debt at beginning of year = 250 - 50 = $200
Book Value of Capital at beginning of year = $ 475.00
EVA = 50 - .0912 (475) = $ 6.68
d Market Value of Equity
ew equity issued, equity affected by retained earnings
Problem 1
Year 1 2 3 5
Growth rate 20% 20% 20% 5%
EBIT (1-t) 100 120 144 151.2
Cost of Equity 15.00% 14.50% 14.00% 12.50%

Cost of Debt 7% 7% 7% 7%
Debt Ratio 10% 20% 30% 40%
Return on Capital 25% 25% 25% 15%
EBIT (1-t) $ 100.00 $ 120.00 $ 144.00 $ 151.20

- Reinvestment $ 80.00 $ 96.00 $ 115.20 $ 50.40
FCFF $ 20.00 $ 24.00 $ 28.80 $ 100.80
Terminal Value $ 2,411.48
Cost of Capital 13.92% 12.44% 11.06% 9.18%
Cumulative WACC 113.92% 128.09% 142.26% 155.32%
PV $ 17.56 $ 18.74 $ 1,715.39
Value of Firm = $ 1,751.68
Reinv. Rate 80.0% 80.0% 80.0% 33.3%
Problem 2
BancFirst Farmers Ban Without syne With Synergy
Net Income $ 144.00 $ 250.00 $ 394.00 $ 424.00
Book Value of Equity $ 1,200.00 $ 2,500.00 $ 3,700.00 $ 3,700.00
Beta 1.00 1.00 1.00 1.00
$ 1,387.64 $ 1,927.27 $ 3,314.91 $ 3,893.09

Value of Synergy = $ 3893 - $3315 = $ 578.18
d. Value of Synergy if it does not start for 4 years = $ 374.08
Problem 3
Status Quo Optimally M Value of Control
Debt Ratio 0.00% 30.00%
Return on Capital 10.00% 15.00%
Beta 0.80 1.01
Cost of Equity 10.40% 11.53%
Cost of Capital 10.40% 9.42%
Reinvestment Rate 50.00% 33.33%
Value $ 1,458.33 $ 3,561.74 $ 2,103.40 ! The improvement in return on capital on existing assets boosts the
b. Expected Market Price today = 1458 + 0.5($2103) = $ 2,510.04 ! Equity investors get it all….
Problem 4
Revenues 12500
- Oper. Exp 11000
- Deprecn 2000
EBIT -500
- Int. Exp 1000
Taxable Income -1500
- Taxes 0
Net Income -1500
a. Value of Firm = 15000

Value of Debt = 8500
b. S = Firm Value= 15000

K = Value of Debt = 20000
r= 6%
T= 6.5
Variance = 0.1223 ! Variance = 12 (Monthly Variance); Monthly Variance= 0.05(.2)2+0.01(.8)2+2(.05)0.5(.01)0.5(.2)
c. N(d1) = 0.7123
N(d2) = 0.3704
Probability of bankruptcy = 29% to 63%
d. Value of Equity = 15000(0.7123) - 20000(exp(-(0.06)(6.5))(.3704) = $ 5,670.00

urn on capital on existing assets boosts the current EBIT
estors get it all….
ce= 0.05(.2)2+0.01(.8)2+2(.05)0.5(.01)0.5(.2)(.8)(.25)
Problem 1 1 2 3 4 Terminal Year
EPS $ 1.50 $ 1.80 $ 2.16 $ 2.59 $ 2.75
FCFE $ (2.00) $ (1.20) $ 0.34 $ 0.09 $ 1.50
Net Cap Ex $ 3.50 $ 3.00 $ 1.82 $ 2.50 $ 1.25
a. Terminal Value of Equity = 1.50/ (.125 - .06) = $ 23.01

Cost of Equity = 7% + 1 (5.5% ) = 12.50%
b. Value per Share today
1 2 3 4
FCFE $ (2.00) $ (1.20) $ 0.34 $ 0.09
Terminal Value $ 23.01
PV at 15.25% $ (1.74) $ (0.90) $ 0.22 $ 13.09 ! Discount at the current cost of equity
Value of the Stock = $ 10.67
Cost of Equity 15.25%
Problem 2
Reinvestment Rate = 5/12.5 = 40%
Reinvestment Amount = 36 ! This year
Firm Value = (150 * .6 - 36)*1.05 / (.10 - .05) = $ 1,134.00
Problem 3
Cost of Capital = 11.40% (.9) + 7.5% (0.6) * .1 = 10.71%
Cost of Equity = 7% + 0.8 * 5.5% = 11.40%
I should have given you a return on capital to let you compute a reinvestment rate. If you assume a zero reinvestment rate, you get
Value/Sales Ratio = .03*1.05 / (.1071 - .05) = 0.5516637478
If you had assumed that the ROC = Cost of capital, the reinvestment rate = 5%/.1071 = 46.69%
Using this reinvestment rate would have lowered the value to sales ratio :.03*.4669*1.05/(.1071-.05) = 0.2575461008
If management is improved,
Unlevered Beta = 0.8 / (1+(1-.4)(1/9)) = 0.75
New Beta = 0.75 (1+ (1-.4) (3/7)) = 0.9428571429
New Cost of Equity = 0.07 + 0.94 (.055) = 0.1218571429
New Cost of Capital = 12.18% (.7) + 8% (1-.4) (.3) = 9.97%
Value/Sales Ratio = .07 *0.6 *1.05/(.0997-.05) = 0.8873239437
The Value/Sales ratio will increase by roughly 0.34.
Problem 4
N(d1) = 0.6517
N(d2) = 0.5675
Probability that the firm will go bankrupt = 0.3483 - 0.4286 (It is equal to 1- N(d))
Value of Equity = 9 = 75 (.6517) - K exp (-.07)(5)(.5675)

K = (75 *.6517 - 9)/ (exp (-0.07)(5)*5714)
Solving,
K = $ 99.72
Implied interest rate= 8.60%
Problem 5
a. Valuing G&P
Capital Invested = 2000
EVA created this year = (.13-.11)(2000) = 40
PV of EVA = 40 *1.05/(.11-.05) = 700
Value of Firm = 2000 + 700 = 2700
b. Valuing BandAdd
Capital Invested = 500
EVA this year = (.16 -.12)(500) = 20
PV of EVA = 20 *1.05/(.12-.05) = 300
Value of Firm = 500 + 300 = 800
c. Capital Invested = 2500

Combined Operating Income = (.13*2000+.16*500) = 340
Restated Operating Income = 340 (1.10) = 374
Restated EVA = (374 - .10*2500) = 124
PV of EVA, assuming 5% growth = 2604
New Firm Value = 2500 + 2604 = 5104
Value of Synergy = 5104 - (2700 + 800) = 1604

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Problem 1 Grading template

ROE 20.00% 18.75% 17.65% 16.67% 15.79% 15.00%

Effective tax 30%

Value of Oper $4,284.00

Strike Pri ### Variance= 0.09

Value of the call = $1,112.67 Value of the put = $1,233.86

se net income in year 6: -1 point

ed terminal value at wrong rate: -1/2 point

ectly: -1/2 point

rectly: -1/2 point

t correctly: -1/2 point

incorrectly: -1/2 to -1 point

ints (depending on magnitude)

Value of operating assets = $2,187.50

Expected Return on Capital = 12.00% 20.00%

a. Cost of capital for typical retail firm

b. Solving for intrinsic EV/Sales for Luxury Retail

c. Solving for revenue growth for online retail ETF

Value of option = $796.20

Value of Zee TV with expansion option $2,296.20

value for minority holding in RigWorks: -1 point

ompute return on capital: -1 point

ompute return on capital: -1 point

nput: -1/2 point each

return on capital: -1 point

return on capital: -1 point

operating income: -1 point

hat is wrong: -1/2 point

way on this input.

Alcoholic Beverages $10.00 5.00% 0% 0.00% $10.00 7% $142.86

Value of equity as a call = $225.71

! Return on capital incorrect: -1 point

! Did not add back net debt: -1 point

! Did not compute reinvestment rate: -1 point

I Did not set up PE equation correctly: -1 point

I Did not set up PE equation correctly: -1 point

I Did not set up PE equation correctly: -1 point

! Did not reestimate reinvestment rate for restaurants: -1 points

! Solved for YTM: -1/2 point

! All other mistakes: -1 point

Revenues 1000 1. Error on computing normalized operating income: -1 point

Probability of nationalization 20%

Brand name companies

ROIC 0.125 0.2 1. Used wrong currency discount rate: -1 point

After the merger

ROIC 13.51% 15.00%

Divestiture proceeds = $900.00

Option to double holding Option to abandon holding

d1 = 0.50 N(d1) = 0.6915 d1 = 1.6552 N(d1) =

Value of option = $42.50 Value of opti $2.35

your proceeds from

for EV/Sales: -1 point

Value of operating assets

1. Did not estimate divestiture proceeds: -1/2 point

alue of business + Cash

1.Inputs wrong for call option: -1 point

Return on equity of financial arm 20%

Equity value of company = 480 ! 320 + 160

ROE for company = 0.125

1.20 = (0.125 -.03)/ (Cost of equity - .03)

SmartCell's intrinsic value of equity = $1,316.67

Cost of capital for the company

Value of the firm = $1,424.05

Invested capital in packaged goods 900