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Assignment 1

You have been asked to value a firm with expected annual after-tax cash flows, before debt payments, of $100 million a year in perpetuity. The firm has a cost of equity of 10%, a market value of equity of $750 million and a market value of debt of $500 million (this is also the book value). The debt is perpetual and the after-tax interest rate on debt is 5%. The company has no non-operating activities.

a. Estimate the value of the firm and the value of the equity based upon this value.

b. Estimate the value of equity, by discounting the cash flows to equity at the cost of equity.

c. Now assume that you had been told that the market value of equity was $850 million and that all of the other information remained unchanged. Answer parts a and b, using these new values.

d. In practice, what needs to happen for the two valuation approaches (FCFF and FCFE) to give the same estimate of value?

Assignment  2

a. Using the financial statements and other information that you have for MPR, and assuming a 5% perpetual growth rate in the FCFE, value the equity using the FCFE method.

b. Does this value equal the estimated value using the FCFF method? Why or why not?

Assignment 3

IO Taxes Inc. is a large but privately-held all-equity firm in the tax planning industry. The firm has been enjoying a nice 20% annual growth in its FCFE due to the highly anticipated increase in taxes related to the massive baby-boomers retirement wave. IO’s FCFE is expected to be $5 million next year. The growth rate is expected to be the same for an additional year after that and then management expects the FCFE’s growth rate to cool down to 4% in perpetuity.

IO Taxes has 10 million shares outstanding and it has $10 million in non-operating cash (invested mostly in Treasury bills).

While IO Taxes is not publicly traded, its close competitor, H&R Rock Inc., is and has an unlevered and unadjusted equity beta of 1.3.

a. Based on the available information, please estimate IO’s cost of equity.

b. Estimate the intrinsic value of each share of stock.

Assignment 1:

Question a:

Calculation of value of firm

Cost of equity =

10.00%

Market value of equity =

750

Market value of debt =

500

After-tax interest rate on debt =

5.00%

Debt/Capital ratio =

0.4

Cost of capital =

8.00%

Cash flow to firm =

$100.00

Value of firm=

$1,250.00

Question b:

Calculation of value of equity

Cash flow to firm

$100.00

 - Interest (1-t)

$25.00

 = Cash flow to equity

$75.00

Value of equity

$750.00

Question c:

Cost of equity =

10.00%

Market value of equity =

850

Market value of debt =

500

After-tax interest rate on debt =

5.00%

Debt/Capital ratio =

0.37

Cost of capital =

8.15%

Cash flow to firm =

$100.00

Value of firm=

$1,227.27

Calculation of value of equity

Cash flow to firm

$100.00

 - Interest (1-t)

$25.00

 = Cash flow to equity

$75.00

Value of equity

$750.00

Question d:

In case of FCFF an FCFE valuation method, it is important for the business to not to have depreciation and amortization expenses, capital expenditure and interest expenses in order to compute and get the same amount of average cash flows of the business. These items create differentiation in the cash flow of the business and affect the valuation process of the business (Gibson, 2011).

Assignment 2:

Question a:

FCFE valuation model

2015

2016

2017

Net income

26592.7

27445.8

31945.7

Add: Depreciation & amortization

0

0

Add: Changes in WC

911.8

5249.7

Add: CAPEX

11042

10458

Add: Net borrowings

6808

7162

46207.6

54815.4

Average =50511.5

Present value of discrete cash flows for next 10 years

Year

FCFF ($'000)

PVF @10%

PV of Cash Flows

1

  53,037.08

      0.909

         48,215.52

2

  55,688.93

      0.826

         46,023.91

3

  58,473.38

      0.751

         43,931.91

4

  61,397.04

      0.683

         41,935.01

5

  64,466.90

      0.621

         40,028.87

6

  67,690.24

      0.564

         38,209.38

7

  71,074.75

      0.513

         36,472.59

8

  74,628.49

      0.467

         34,814.74

9

  78,359.92

      0.424

         33,232.25

10

  82,277.91

      0.386

         31,721.70

Total

       394,585.87

Assumptions: It has been estimated that the cost of capital of the business is 6%.

FCFE valuation model

2015

2016

2017

EBIT

44321.1

45743

53242.9

Tax rate

17728.4

18297.2

21297.2

EAT

26592.7

27445.8

31945.7

ADD: Noncash charges

0

0

Add: Changes in WWC

911.8

5249.7

Less: Capital expenditure

11042

10458

81355.8

101277.5

91316.65

Present value of discrete cash flows for next 10 years

Year

FCFF ($'000)

PVF @10%

PV of Cash Flows

1

      95,882.48

      0.909

       87,165.89

2

    100,676.61

      0.826

       83,203.81

3

    105,710.44

      0.751

       79,421.82

4

    110,995.96

      0.683

       75,811.73

5

    116,545.76

      0.621

       72,365.75

6

    122,373.04

      0.564

       69,076.39

7

    128,491.70

      0.513

       65,936.56

8

    134,916.28

      0.467

       62,939.44

9

    141,662.10

      0.424

       60,078.56

10

    148,745.20

      0.386

       57,347.71

Total

     713,347.66

Question b:

The computation in question a explains that the value of equity in both the methods, FCFF and FCFE is different because of the changes in the depreciation and amortization expenses, capital expenditure and interest expenses of the business. These factors have affected the total value of equity of the business (Higgins, 2012).

Assignment 3:

Question a:

Cost of Equity: CAPM model

A. Risk free rate

3.20%

B. Market rate of return

5.40%

C. Beta

1.3

D. CAPM

6.06%

Question b:

Valuation of equity taking free cash flows of firm

Past average

FCFF ($'000)

        5.00

Growth rate

20.00%

Applied for next 10 years

Perpetual growth rate

4.00%

Applied after 10 years

Estimated Free cash flows for firm

Year

FCFF ($' M)

Remarks

2018

        6.00

=5*(1+20%)

2019

        7.20

2020

        7.49

2021

        7.79

2022

        8.10

2023

        8.42

2024

        8.76

2025

        9.11

2026

        9.47

2027

        9.85

Terminal cash flows

      10.25

=9.85*(1+4%)

Present value of discrete cash flows for next 10 years

Year

FCFF ($'000)

PVF @6.06%

PV of Cash Flows

1

        6.00

      0.943

        5.66

2

        7.20

      0.889

        6.40

3

        7.49

      0.838

        6.28

4

        7.79

      0.790

        6.15

5

        8.10

      0.745

        6.03

6

        8.42

      0.703

        5.92

7

        8.76

      0.662

        5.80

8

        9.11

      0.625

        5.69

9

        9.47

      0.589

        5.58

10

        9.85

      0.555

        5.47

Total

      58.99

Present value of terminal cash flows

Terminal cash flows

      10.25

      73.51

Total firm value

    132.50

Less: Value of Debt

      10.00

Total value of Equity

    122.50

No of Shares Outstanding

      10.00

Per share value of value of equity (intrinsic value)

      12.25

References:

Gibson, C. H. (2011). Financial reporting and analysis. South-Western Cengage Learning.

Higgins, R. C. (2012). Analysis for financial management. McGraw-Hill/Irwin.

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My Assignment Help. (2021). Valuation Of A Firm And Its Equity. Retrieved from https://myassignmenthelp.com/free-samples/surv6720-land-valuation/financial-reporting-and-analysis.html.

My Assignment Help (2021) Valuation Of A Firm And Its Equity [Online]. Available from: https://myassignmenthelp.com/free-samples/surv6720-land-valuation/financial-reporting-and-analysis.html
[Accessed 23 July 2024].

My Assignment Help. 'Valuation Of A Firm And Its Equity' (My Assignment Help, 2021) <https://myassignmenthelp.com/free-samples/surv6720-land-valuation/financial-reporting-and-analysis.html> accessed 23 July 2024.

My Assignment Help. Valuation Of A Firm And Its Equity [Internet]. My Assignment Help. 2021 [cited 23 July 2024]. Available from: https://myassignmenthelp.com/free-samples/surv6720-land-valuation/financial-reporting-and-analysis.html.

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