QUIZ

Variant 1 A- M
1) International company AAA, a leading creator and manufacturer of fragrances, paid out
dividends of $0.91 per share on earnings per share of $1.64 in 2012. The firm is expected to have
a return on equity of 20% between 2013 and 2016, after which the firm is expected to have stable
growth of 8% a year (the return on equity is expected to drop to 15% in the stable growth phase.)
The dividend payout ratio is expected to remain at the current level from 2013 to 2016. The
stock has a beta of 1.12, which is not expected to change. The treasury bond rate is 6%.
A. Estimate the P/E ratio for International company AAA, based upon fundamentals.
B. Estimate how much of this P/E ratio can be ascribed to the extraordinary growth in earnings
that the firm expects to have between 2013 and 2016.
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2) The following are the projected cash flows to equity and to the firm over the next five years:
CF to
Year Int (1-t) CF to Firm
Equity
1 $250.00 $90.00 $340.00
2 $262.50 $94.50 $357.00
3 $275.63 $99.23 $374.85
4 $289.41 $104.19 $393.59
5 $303.88 $109.40 $413.27
Terminal
$3,946.50 $6,000.00
Value
(The terminal value is the value of the equity or firm at the end of year 5.)
The firm has a cost of equity of 13% and a cost of capital of 9.5 %. Answer the following
questions:
A. What is the value of the equity in this firm?
B. What is the value of the firm?
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3) MC has 750 million shares trading at $58 per share and $71 billion in debt outstanding (with a
market value of $67 billion), on which it incurred an interest expense of $6 billion in the most
recent year. It also has $4 billion in preferred stock outstanding, trading at par, on which it paid a
dividend of $370 million. The stock has a beta of 1.15 and is rated A (which commands a spread
of 1.25% over the treasury bond rate of 6.25%). The company faced a corporate tax rate of 40%.
A. What is the cost of equity for MC?
B. What is the after-tax cost of debt for MC?
C. What is the cost of preferred stock?
D. What is the cost of capital?
4) Corox Inc. is a chemical manufacturing company which reported earnings before
interest and taxes of $ 150 million this year. The firm has a cost of capital of 10%, a tax
rate of 40% and expects earnings to grow 5% a year in perpetuity. You know that the
firm has no working capital requirements but does have net capital expenditures that it
needs to make to grow. The firm has return on capital of 12.5% that it expects to maintain
in perpetuity.
a. Estimate the net capital expenditures for Corox, given the expected growth rate and
return on capital.
b. Estimate the value of the firm.
 QUIZ
Variant 2 N-Z
1) Free air, a producer of aircraft, reported net income of $220 million in 2013, after paying
interest expenses of $ 29 million. The depreciation allowance in 2013 was $87 million, while
capital expenditures amounted to $88 million in the same year. Working capital increased by $20
million in 2013. (The tax rate is 40%.) Free air finances 12% of its net capital investment and
working capital needs using debt. The free cash flows to equity are expected to grow 11% a year
from 2014 to 2017, and 6% a year after that. The stock had a beta of 0.85, and this is expected to
remain unchanged. The treasury bond rate is 7,5 %.
A. Estimate the Price/FCFE ratio for the firm.
B. Free air has $281 million in debt outstanding at the end of 2013. What is the Value/FCFF
ratio? the Value/EBITDA ratio? Why are they different from the Price/FCFE ratio?
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2) The following companies reflect the situation in the field of computer development. Financial
information is presented below:

Current Growth Rate in

Apple $32.00 $1.06 15.0% 1.10

HP. $25.00 $1.25 4.0% 1.30

City (ADR) $25.00 $0.27 10.0% 0.75

Microsoft $84.00 $0.00 NMF 1.30

(Microsoft has an expected growth rate in earnings of 24% for the next five years.)

A. Estimate the cost of equity using the dividend growth model. Which, if any, of these firms
may be reasonable candidates for using this model? Why?

B. Estimate the cost of equity using the CAPM. (The thirty-year bond rate is 7.25%.)

C. Which estimate will you use in valuation and why?

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3) MC has 750 million shares trading at $58 per share and $71 billion in debt outstanding (with
a market value of $67 billion), on which it incurred an interest expense of $6 billion in the most
recent year. It also has $4 billion in preferred stock outstanding, trading at par, on which it paid a
dividend of $370 million. The stock has a beta of 1.15 and is rated A (which commands a spread
of 1.25% over the treasury bond rate of 6.25%). The company faced a corporate tax rate of 40%.
A. What is the cost of equity for MC?
B. What is the after-tax cost of debt for MC?
C. What is the cost of preferred stock?
D. What is the cost of capital?

4) JTI1 is a firm that reported net income of -$50 million in the most recent financial year. The
firm had $ 1 billion in debt, on which it reported interest expenses of $ 100 million in the most
recent financial year. The firm had depreciation of $ 100 million for the year, and capital
expenditures were 200% of depreciation. Assuming that there is no working capital requirement,
estimate the free cash flow to the firm in the most recent financial year.
4) Duofold plc

You are a shareholder in Duofold plc, a listed company with an issued share capital of 10m ordinary £1 shares with
a current market price of £1.80 per share at the close of business yesterday afternoon. Today you are to attend the
company's annual general meeting, and just before the meeting begins you are in conversation with a number of
fellow shareholders.

1. (1)  The first shareholder is Alan Jones who owns 2,000 shares in Duofold plc. He expresses great concern
that before the market opened this morning the company announced its intention to pursue a 1-for-2 rights
issue at £1.00 per share to raise funds for a new project that it claimed has a net present value of £2 million.
'This massive discount to the market price is atrocious, and the consequent fall in the share price will be
bad news for me.'

2. (2)  The second shareholder, Peter Atkins, produces a recent investment bank report that hints at a possible
acquisition by Duofold plc of its principal UK competitor. The report states that the annual cash flows of
Duofold are currently £4.2 million and that 'an appropriate discount rate for these cash flows is 12%'. The
report goes on to estimate that combined annual cash flows would total £6.8 million and that 'the
appropriate discount rate for these cash flows is 10%'. Peter's concern is

that he does not know what would be a reasonable price for the directors to pay in such circumstances, as the report
makes no reference to a likely purchase price.

(3) The final shareholder is Norma Benbow, who is concerned by rumours that Duofold plc might be about to cut its
dividend, because she has read that a cut in dividend by another company adversely affected that company's share
price. At the same time, however, Norma mentions that a friend has suggested that a company's dividend policy is
irrelevant. She is confused.

Requirements

1. 43.1  Advise Mr Jones of his various options in such a scenario, making clear to him the expected ex- rights
price of the company's ordinary shares, how much he could reasonably sell his rights for (if he chose to)
and provide calculations to illustrate to him the effect on his wealth of each of the options available to him.

2. 43.2  Calculate for Mr Atkins the maximum price the directors of Duofold plc should consider paying for
this acquisition, and advise him of the potential reasons why the directors of Duofold plc might recommend
an acquisition to their shareholders.

3. 43.3  Outline to Mrs Benbow the theoretical and practical positions regarding the relevance or otherwise of
a company's dividend policy.