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Unformatted text preview: Midterm Exam #2  Solutions Finance 325 October 28, 2010 N a m e : Exam Instructions: • This exam should have 7 pages (including this one) and 6 questions. The point value is given for each problem. The entire exam is worth 100 points. • You may use a calculator and the provided formula sheet on this exam. • You must show your work in order to receive credit for your answers. Partial credit will be given for partially correct answers. • If a question asks “Why/Explain”, you should give an explanation that would convince a skeptic. • You may use the back of a page if you need additional space to write an answer. Suggestions: • Use your time wisely. Move on to another problem if you feel like you’re stuck. • You may ask me questions if you are unclear about a problem. I may be able to clarify the problem for you. GOOD LUCK!! 1. You are trying to determine the share price of AWW, which is in the pet grooming business. It is not publicly traded, but you know that it has 200,000 shares outstanding, and has expected earnings this year of $255,000 and expected cash flows of $400,000. You find that publiclytraded pet grooming companies have an average P/E ratio of 34 and an average P/CF ratio of 29. What would be a good range of price estimates for the share price of AWW? (14 pts) We can use price multiples of similar companies (in the same industry) to get a sense of what the value of the firm is, and then divide by the number of shares outstanding to get an approximate share price: Using P/E ratio: Using P/CF ratio share M M share P M P P E P / 35 . 43 $ 2 . 67 . 8 $ 67 . 8 000 , 255 34 = = = = = share M M share P M P P CF P / 00 . 58 $ 2 . 6 . 11 $ 6 . 11 $ 000 , 400 29 = = = = = So a good range of estimates would be between $43.35 and $58 per share 2. AWW (the same company from above) needs to purchase a new petdrying machine. They can buy either the DryOMatic or the NoMorWet machine. The DryOMatic costs $18,000, will last 7 years, and requires maintenance expenditures of $2,000 per year for the life of the machine. The NoMorWet costs $24,000, will last 9 years, and will require $1,750 per year in maintenance during its life. Whichever machine AWW buys, they plan to continue buying the same machine indefinitely. Which machine should they choose if their cost of capital is 19%? (16 pts) Since AWW will be repeating this investment indefinitely, and the lives of the projects are not the same, we cannot use the NPV of each investment… we can solve using same end year or EAA....
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 Winter '09
 FREEDMAN
 Net Present Value, PBR, EAAN −M −W

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