Valuation Problems in Corporate Finance

Problem 1: Valuing the Equity of a Stable-Growth Firm

Task:

You must show your work in excel worksheet for full credit; showing your work will also ease getting partial credit. I have shown the available points for each problem.
 
Please consolidate your excel files and submit only one workbook with a separate tab for each question. Also do not forget to name the tabs to identify the questions/problems.  For the problems out of the Valuation textbook, you may use the spreadsheet templates provided under the Course Document tab in Blackboard.

 
Question 1.
8- Valuing the Equity of a Stable-Growth Firm
The Emerson Electric Company (EMR) was founded in 1890 and is located in St. Louis Missouri. The firm provides product technologies and engineering service for industrial, commercial, and consumer markets worldwide. The firm operates in five business segments: process management, industrial automation, network power, climate technologies, and appliance and tools.
The company has a lengthy history of dividend payments and steady growth. In recent years, the firm’s dividend payout has averaged 40% of earnings.
1. Is Emerson’s current stock price reasonable in light of its sector, industry, and comparison firms?
2. Emerson’s beta coefficient is 1.27. Assuming a risk-free rate of 5.02% and a market risk premium of 5%, what is your estimate of the required rate of return for Emerson’s stock using the CAPM? What rate of growth in earnings is consistent with Emerson’s policy of paying out 40% of earnings in dividends and the firm’s historical return on equity? Using your estimated growth rate, what is the value of Emerson’s shares using the Gordon growth model? Analyze the reasonableness of your estimated value per share using the Gordon model.

Question 2.  Answer problem #9-9 on page 352 from the TM textbook. (30 points)
Terminal value refers to the valuation attached to the end of the planning period; it captures the value of all subsequent cash flows. Estimate the value today for each of the following sets of future cash flow forecasts.
a.Claymore Mining Company anticipates that it will earn firm FCFs of $4 million per year for each of the next five years. Beginning in year 6, the firm will earn FCF of $5 million per year for the indefinite future. If Claymore’s cost of capital is 10%, what is the value of the firm’s future cash flows?
b.Shameless Commerce Inc. has no outstanding debt and is being evaluated as a possible acquisition. Shameless’s FCFs for the next five years are projected to be $1 million per year, and, beginning in year 6, the cash flows are expected to begin growing at the anticipated rate of inflation, which is currently 3% per annum. If the cost of capital for Shameless is 10%, what is your estimate of the present value of the FCFs?
c.Dustin Electric Inc. is about to be acquired by the firm’s management from the firm’s founder for $15 million in cash. The purchase price will be financed with $10 million in notes that are to be repaid in $2 million increments over the next five years. At the end of this five-year period, the firm will have no remaining debt. The FCFs are expected to be $3 million a year for the next five years. Beginning in year 6, the FCFs are expected to grow at a rate of 2% per year into the indefinite future. If the unlevered cost of equity for Dustin is approximately 15% and the firm’s borrowing rate on the buyout debt is 10% (before taxes at a rate of 30%), what is your estimate of the value of the firm?

Question 3. Answer problem #11-8 on page 430 from the TM textbook (ignore the tracking portfolio portion of the spreadsheet template). (30 points)

Question 4.  Answer problem #12-5 on page 484 from the TM textbook. (30 points)
VALUING AN AMERICAN OPTION J&B Drilling Company has recently acquired a lease to drill for natural gas in a remote region of southwest Louisiana and southeast Texas. The area has long been known for oil and gas production, and the company is optimistic about the prospects of the lease. The lease contract has a three-year life and allows J&B to begin exploration at any time up until the end of the three-year term. J&B’s engineers have estimated the volume of natural gas they hope to extract from the leasehold and have placed a value of $25 million on it, on the condition that explorations begin immediately. The cost of developing the property is estimated to be $23 million (regardless of when the property is developed is developed over the next three years). Bases on historical volatilities in the returns of similar investments and other relevant information, J&B’s analysts have estimated that the value of the investment opportunity will evolve over the next three years. The risk-free rate of interest is currently 5%, and the risk-neutral probability of an uptick in the value of the investment is estimated to be 46.26%. A. Evaluate the value of the leasehold as an American call option. What is the Lease worth today? B. As one of J&B’s analysts, what is your recommendation as to when the company should drilling?

Question 5. Answer the following problem based on the Corporate Financial Analysis textbook.  (30 points)

The following is a spreadsheet for forecasting annual revenues for the Gorsuch Corp.

The data has been correctly entered in Cells C4:C17 and the LINEST output in Cells C21:D25 is correct.
a. Complete the following sentence: “The linear model is (or is not) a valid model of the trend of the data because …”
b. Identify any errors in the model’s specification.

c. An incorrect entry has been made in one cell and then copied down.  You should be able to spot the cell without making any calculations.  Identify the cell and indicate the correct entry for it.