Project #21927 - Valuation

 

 

Question 1

 

 

 

    Suppose that Boston Scientific is considering making an investment of $500 million in a new stent production technology. The Net Present Value of the project is very positive and the Internal Rate of Return on the project is 250%. The Company’s WACC is 15%. The Board is very impressed with the 250% IRR. Based on these numbers, should the project be accepted? Is the 250% IRR a good measure of the project’s annual percentage rate of return? If not, describe an improved method for measuring the annual rate of return and note why it is an improvement.

 

10 points 

 

 

 

Question 2

 

 

 

    Assume that Thompson, Inc. generated free cash flow of $1,000 last year. Thomson’s weighted average cost of capital is 11%. Estimate the value of Thomson’s equity under the following growth rate of free cash flow assumptions.

 

 

 

    Year 1         25%

 

    Year 2         20%

 

    After Year 2 through Year 10     Declining linearly from 20% to 5%

 

    Beyond Year 10    Continuing at 5% per year indefinitely

 

    Value of Debt         $10,000

 

 

 

Question 3

 

 

 

    Now we will explore seven changes. There are three multiple-choice questions for each of the following changes (each considered independently, holding everything else constant). Choose the effect of the change on this year’s NOPAT (first question), Investment (second question), and Free Cash Flow (third question).

 

 

 

    1) A decrease in the operating profit margin.

 

 

 

    Choose the effect on this year's NOPAT.

 

                       

 

    Increase

 

                       

 

    Decrease

 

                       

 

    No Effect

 

 

 

1 points 

 

Question 4

 

 

 

 

 

 

 

    1) A decrease in the operating profit margin.

 

 

 

    Choose the effect on this year’s Net Operating Capital.

 

                       

 

    Increase

 

                       

 

    No Effect

 

                       

 

    Decrease

 

 

 

1 points 

 

Question 5

 

 

 

 

 

 

 

    1) A decrease in the operating profit margin.

 

 

 

    Choose the effect on this year’s Free Cash Flow.

 

                       

 

    Increase

 

                       

 

    No Effect

 

                       

 

    Decrease

 

 

 

1 points 

 

Question 6

 

 

 

 

 

 

 

    2) An increase in Beta.

 

 

 

    Choose the effect on this year’s NOPAT.

 

                       

 

    Increase

 

                       

 

    Decrease

 

                       

 

    No Effect

 

 

 

1 points 

 

Question 7

 

 

 

 

 

 

 

    2) An increase in Beta.

 

 

 

    Choose the effect on this year’s Net Operating Capital.

 

                       

 

    Increase

 

                       

 

    Decrease

 

                       

 

    No Effect

 

 

 

1 points 

 

Question 8

 

 

 

 

 

 

 

    2) An increase in Beta.

 

 

 

    Choose the effect on this year’s Free Cash Flow.

 

                       

 

    Increase

 

                       

 

    Decrease

 

                       

 

    No Effect

 

 

 

1 points 

 

Question 9

 

 

 

 

 

 

 

    3) An increase in accounts receivable.

 

 

 

    Choose the effect on this year’s NOPAT.

 

                       

 

    Decrease

 

                       

 

    No Effect

 

                       

 

    Increase

 

 

 

1 points 

 

Question 10

 

 

 

 

 

 

 

    3) An increase in accounts receivable.

 

 

 

    Choose the effect on this year’s Net Operating Capital.

 

                       

 

    No Effect

 

                       

 

    Decrease

 

                       

 

    Increase

 

 

 

1 points 

 

Question 11

 

 

 

 

 

 

 

    3) An increase in accounts receivable.

 

 

 

    Choose the effect on this year’s Free Cash Flow.

 

                       

 

    No Effect

 

                       

 

    Decrease

 

                       

 

    Increase

 

 

 

1 points 

 

Question 12

 

 

 

 

 

 

 

    4) A decrease in plant and equipment (No depreciation impact).

 

 

 

    Choose the effect on this year’s NOPAT.

 

                       

 

    No Effect

 

                       

 

    Increase

 

                       

 

    Decrease

 

 

 

1 points 

 

Question 13

 

 

 

 

 

 

 

    4) A decrease in plant and equipment (No depreciation impact).

 

 

 

    Choose the effect on this year’s Net Operating Capital.

 

                       

 

    No Effect

 

                       

 

    Increase

 

                       

 

    Decrease

 

 

 

1 points 

 

Question 14

 

 

 

 

 

 

 

    4) A decrease in plant and equipment (No depreciation impact).

 

 

 

    Choose the effect on this year’s Free Cash Flow.

 

                       

 

    Increase

 

                       

 

    Decrease

 

                       

 

    No Effect

 

 

 

1 points 

 

Question 15

 

 

 

 

 

 

 

    5) An increase in revenue growth without any increase in assets.

 

 

 

    Choose the effect on this year’s NOPAT.

 

                       

 

    Decrease

 

                       

 

    Increase

 

                       

 

    No Effect

 

 

 

1 points 

 

Question 16

 

 

 

 

 

 

 

    5) An increase in revenue growth without any increase in assets.

 

 

 

    Choose the effect on this year’s Net Operating Capital.

 

                       

 

    Decrease

 

                       

 

    Increase

 

                       

 

    No Effect

 

 

 

1 points 

 

Question 17

 

 

 

 

 

 

 

    5) An increase in revenue growth without any increase in assets.

 

 

 

    Choose the effect on this year’s Free Cash Flow.

 

                       

 

    No Effect

 

                       

 

    Decrease

 

                       

 

    Increase

 

 

 

1 points 

 

Question 18

 

 

 

 

 

 

 

    6) A decrease in accounts payable.

 

 

 

    Choose the effect on this year’s NOPAT.

 

                       

 

    Decrease

 

                       

 

    No Effect

 

                       

 

    Increase

 

 

 

1 points 

 

Question 19

 

 

 

 

 

 

 

    6) A decrease in accounts payable.

 

 

 

    Choose the effect on this year’s Net Operating Capital.

 

                       

 

    Increase

 

                       

 

    Decrease

 

                       

 

    No Effect

 

 

 

1 points 

 

Question 20

 

 

 

 

 

 

 

    6) A decrease in accounts payable.

 

 

 

    Choose the effect on this year’s Free Cash Flow.

 

                       

 

    No Effect

 

                       

 

    Decrease

 

                       

 

    Increase

 

 

 

1 points 

 

Question 21

 

 

 

 

 

 

 

    7) An increase in the tax rate.

 

 

 

    Choose the effect on this year’s NOPAT.

 

                       

 

    Increase

 

                       

 

    Decrease

 

                       

 

    No Effect

 

 

 

1 points 

 

Question 22

 

 

 

 

 

 

 

    7) An increase in the tax rate.

 

 

 

    Choose the effect on this year’s Net Operating Capital.

 

                       

 

    No Effect

 

                       

 

    Decrease

 

                       

 

    Increase

 

 

 

1 points 

 

Question 23

 

 

 

 

 

 

 

    7) An increase in the tax rate.

 

 

 

    Choose the effect on this year’s Free Cash Flow.

 

                       

 

    Decrease

 

                       

 

    Increase

 

                       

 

    No Effect

 

 

 

1 points 

 

Question 24

 

 

 

    Suppose that Proctor and Gamble is considering instituting a bonus system for all of its business units. The bonus calculation will be based on growth in revenue and growth in operating profit. Critique this bonus system and identify a problem that might arise. Suggest a performance target, other than growth in revenue and growth in operating profit, that might alleviate this problem. Explain.

 

 

 

10 points 

 

Question 25

 

 

 

    Suppose Apple has excess cash invested in US Treasury Bonds earning 3%. They are considering acquiring a web-based telecommunications company, which is similar to Apple’s existing business, for $20 billion. Apple’s WACC is 12%. What is the appropriate discount rate to use in evaluating the acquisition? Explain clearly and concisely why this is the appropriate discount rate.

 

 

 

10 points 

 

Question 26

 

 

 

    Total Value: 15 Points

 

 

 

    Consider the data in Exhibit 8 of the Pepsico, Inc.: Cost of Capital case and the following information. Assume a risk-free rate of 8.3%, a market risk premium of 7.2%, and a tax rate of 38%. Use total debt to measure debt and market value of equity to measure equity.

 

 

 

Use the pure-play method (including adjusting for financial risk), to estimate an adjusted weighted average cost of capital for the snack foods segment. Use Goodmark Foods as the pure-play company for snack foods.

 

 

 

10 points 

 

Question 27

 

 

 

    Part B (5 Points)

 

    Why is it important for Pepsi to estimate an adjusted cost of capital for each segment?

 

 

 

5 points 

 

Question 28

 

Assumptions

 

Risk-free rate

4.36% 10-year Treasury

Equity risk premium

4.50% Historical equity risk premium

Beta

1.15 Adjusted daily beta

Cost of equity

9.54%

Revenue growth 06 to 08

12.50%

Revenue growth 09 to 14

6.50%

Terminal growth rate

5.5% GDP

Margin—stable @30% going forward

 

Estimate of 35% of cash flow to be reinvested

 

 

 

 

($MM)

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Terminal

Year

0

1

2

3

4

5

6

7

8

9

10

10

Revenues

5,153

5,721

6,436

7,240

8,145

8,675

9,238

9,839

10,479

11,160

11,885

310,748

Margin

28.55%

30.63%

30.00%

30.00%

30.00%

30.00%

30.00%

30.00%

30.00%

30.00%

30.00%

30.00%

Pre-tax income

1,471

1,752

1,931

2,172

2,444

2,602

2,772

2,952

3,144

3,348

3,566

93,224

Tax rate

33.20%

34.00%

34.00%

34.00%

34.00%

34.00%

34.00%

34.00%

34.00%

34.00%

34.00%

34.00%

After-tax income

983

1,157

1,274

1,434

1,613

1,718

1,829

1,948

2,075

2,210

2,353

61,528

Maintenance capital

344

405

446

502

564

601

640

682

726

773

824

21,535

Free cash flow

639

752

828

932

1,048

1,116

1,189

1,266

1,349

1,436

1,530

39,993

 

 

 

 

 

 

 

 

 

 

 

 

 

2004 DCF

$23,504

 

 

 

 

 

 

 

 

 

 

 

Shares outstanding

344

 

 

 

 

 

 

 

 

 

 

 

Near-term value

$68.25

                     

 

 

 

 

 

 

 

    Use the information in Question 28 to answer Questions 29-32.

 

 

 

    Exhibit 10.0 below presents a recent discounted cash flow valuation of State Street contained in an analyst's report prepared by Atlantic Equities, LLP. Review the analysis and answer the following questions. Note that in this valuation, interest expense is deducted in determining free cash flow; hence the free cash flow is to equity and is discounted at the cost of equity to arrive at the estimated value of equity. Assume the value of State Street's debt is $20 billion.

 

 

 

    Exhibit 10.0 State Street Discounted Cash Flow Calculation $MM unless stated

 

Question 29

 

 

 

    Part A: Use the data provided to estimate the cost of equity for State Street. Do you agree with the 9.54% figure?

 

 

 

 

 

5 points 

 

Question 30

 

 

 

    Part B: Estimate the terminal value at the end of year 10. Do you agree with the $39,993 figure?

 

 

 

 

 

5 points 

 

 

 

Question 31

 

 

 

    Part C: Suppose that it is now the end of 2004 and that State Street generated $639 million of free cash flow in 2004. You expect free cash flow to grow at a constant annual rate of 5%. The discount rate is 9.54%. Estimate the value per share of State Street's equity with these assumptions.

 

5 points 

 

 

 

Question 32

 

 

 

    Part D: Suppose that it is now the end of 2004 and that State Street generated $639 million of free cash flow in 2004. You expect free cash flow growth to decline from 15% to 4% over the next fifteen years, after which it will remain at 4%. The discount rate is 9.54%. Estimate the total value of State Street's assets with these assumptions.

 

 

 

 

 

 

 

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Due By (Pacific Time) 02/02/2014 11:15 am
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