Topic 14: Firm Valuation

What is the company valuation given the following? Cash flows: Yr 1 $80,000, Yr 2 $100,000, Yr 3 $95,000, Yr 4 $80,000, Discount rate 7% 355,000 242,090 300,690 61,032

Answer: 300,690 N FV I/Y PV 1 80000 7 74,766 2 100000 7 87,344 3 95000 7 77,548 4 80000 7 61,032 300,690

Orange Zest Cafe is seeking to buy Wild Parsley Grill. Wild Parsley is a private company. Wild Parsley Grill had an EPS of $2.80 last year and has 125,000 shares outstanding. Orange Zest stock sells for $43 and has an EPS of $5. Orange is larger than Wild Parsley but sees both companies as operating in similar markets. What is the value of Wild Parsley? 3,010,000 1,920,000 2,800,000 5,375,000

Answer: 3,010,000 43.00 / 5.00 = 8.60 PE ratio 8.6 PE * 2.8 EPS * 125,000 Shares O/S = 3,010,000

You have worked hard for the past 3 years to get your start-up venture off the ground. You now may have the chance to harvest your business by selling out to BigBoy Company. On your income statement, you have Sales of $10 million, EBITDA of $2.5 million, and earnings of $1.5 million. Through negotiation, you have agreed on a P/EBITDA ratio of 5. How much is your firm worth? $2.5 million $7.5 million $12.5 million $50 million Not enough data to tell

Answer: $12.5 million EBITDA = $2.5 million P/EBITDA = 5 2.5 * 5 = $12.5 million

JackerCracks is trying to value their firm. Their forecast of EBIT (in millions of dollars) for the next three years is $15, 21, 28. Assume depreciation is $3 million per year, CAPEX will be $2 million each year, and net working capital will not change. After the third year free cash flows will be constant at $30 million per year, You compute a WACC of 15%. Assume a corporate tax rate of 38%. What is the value of JackerCracks using a DCF approach? $333.45 $283.24 $163.13 $485.99 $103.58

Answer: $163.13 Terminal Value = 30/.15 = 200 Year 1 FCFF = 15*(1-.38) + 3 - 2 = 10.3 Year 2 FCFF = 21*(1-.38) + 3 - 2 = 14.02 Year 3 FCFF = 28*(1-.38) + 3 - 2 = 18.36 + 200 = 218.36 Calculate NPV of cash flows R = .15 NPV = $163.13

Calculate the free cash flow given the following information: Net working capital increases by 20,000 Tax rate is .40 EBIT is 250,000 Capital expenditures are 10,000 Depreciation is 15,000 115,000 200,000 135,000 175,000

Answer: 135,000 250,000 (1-.40) + 15,000 - 20,000 - 10,000 = 135,000

What is the discounted cash flow of the company with the following cash flows? Cash flows: Yr 1 $100,000, Yr 2 $150,000, Yr 3 $150,000, and future forecasted annual cash flows $100,000. Discount rate is 5%. 2,360,868 1,727,675 2,088,543 2,400,000

Answer: 2,088,543 N FV I/Y PV 1 100,000 5 95,238 2 150000 5 136,054 3 150000 5 129,576 Infin 100000 -- Perpetuity: 100,000 / .05 = 2,000,000 3 2,000,00 5 1,727,675 Find PV using same int rate and last yr of annual values 2,088,543

If a company has a constant growth rate estimated at 5% and a free cash flow of $150,000, what is its estimated valuation (terminal value)? 1,500,000 2,500,000 7,500 3,000,000

Answer: 3,000,000 150,000 / .05 = 3,000,000

Bullzai Inc. is seeking to sell the company, but it is a private company with no sales of stock to determine its market value. It has earnings of $1,200,000 on 350,000 shares. Endothon Company is a direct competitor and of equal size and profitability. Its stock sells for $21 per share and has earnings per share of $3.80. What is the value of Bullzai? 6,632,000 1,330,000 7,350,000 7,000,000

Answer: 6,632,000 1,200,000/350,000 = 3.4286 earnings per share 21 / 3.80 = 5.5263 multiple $3.4286 * 5.5263 * 350,000 = 6,631,615

Which type of firm would the replacement cost method be most appropriate for? 50-year old firm with many patents Coca-Cola (with brand image and trade secret) Young, tech start-up A holding company that primarily holds real estate assets

Answer: A holding company that primarily holds real estate assets

Which of the following is NOT one of the ways to value a firm that was covered in this topic? Replacement cost Comparable multiples Discounted cash flows (DCF) All of these are methods None of these are methods

Answer: All of these are methods

The DCF method serves as a good review for all of the following except? Free cash flow measures Time value of money Cost of capital Capital budgeting All of these choices

Answer: All of these choices

What would be a source of information to determine replacement cost? Building appraisal Statement of cash flows Stock price Accumulated depreciation expense

Answer: Building appraisal

What is the equation for FCFF? EBIT(1-t) - Depreciation - CAPEX - Increase in NWC EBIT(1-t) + Depreciation + CAPEX - Increase in NWC EBIT(1-t) + Depreciation - CAPEX - Increase in NWC EBIT(1-t) + Depreciation + CAPEX + Increase in NWC None of these choices

Answer: EBIT(1-t) + Depreciation - CAPEX - Increase in NWC

What is the name of the reciprocal of the P/E ratio (P/E flipped upside down, E/P) called? Price yield None of these choices Earnings yield Epi Ratio P/E

Answer: Earnings yield

The difference between FCFF and FCFE is that FCFE takes out interest expense and adjusts for long-term debt changes.

Answer: False Because FCFE starts with net income, it also takes into account the tax shield created by using debt.

DCF is typically used for young, entrepreneurial firms.

Answer: False DCF typically is best suited for established firms for which forecasting is fairly reliable.

The cost method is best for firms with a lot of intangible assets.

Answer: False It is difficult to value intangible assets - so this is one disadvantage to the replacement cost approach.

It is better to use book values in the cost method than to estimate market values.

Answer: False Market values are ideal. Sometimes book values are used if market values cannot be obtained or book values are recent enough that they are deemed close to market value.

In the DCF approach, we use some kind of FCF measure in the denominator.

Answer: False The FCF measure is used in the numerator.

During the dot.com bubble, which comparable multiple became popular because many IPOs did not have positive earnings? M/B P/EBITDA None of these choices P/E P/S

Answer: P/S Price/sales

The last cash flow in the DCF approach which typically uses a model such as the Gordon Growth model to estimate all of the future cash flows beyond a certain point is called? Estimation period value Terminal value End value Maturity value

Answer: Terminal value

If two companies have earnings of $2,000,000, and Company X has a multiple of 1.2 and Company Z has a multiple of 2.0, what can be estimated about the value of each company? The value of Company Z is higher. The relative value cannot be determined. The value is the same. The value of Company X is higher.

Answer: The value of Company Z is higher.