FINC6316 Financial Statement Analysis
Assignment #5 Solution
(Total
51 points possible, Worth 10% of final grade)
Name: ____________________________________________

Part 1. Valuation basics
Question 1
Assume that a company’s free cash flows are projected to remain at $1,000,000 each year, and
that its cost of capital for operations is 10%. Estimate the value of the firm. (3 points)
V = 1,000,000 / 0.10 =10,000,000
Question 2
Assume that a company’s
dividends per share are
projected to grow at 2% each
year, its next year’s divi-
dends per share is $1.20, and its
cost of equity capital is 5%.
Estimate the company’s per
share stock price.
Assume that a company’s free cash flows are projected to grow at 3% each year, its next year’s
free cash flow is $1,000,000, and its cost of capital for operations is 10%. Estimate the value of
the firm. (3 points)
2

V = 1,000,000 / (0.10 – 0.03) = 14,285,714
3

Question 3
In the year 2012, a real estate analyst forecasts that a rental apartment building will generate
$5.3 million each year in rent over the five years 2013- 2017. Cash expenses are expected to be
$4.2 million a year. At the end of five years, the building is expected to sell for $12 million. Real
estate investors require a 12 percent return on their investments. Apply present value discounting
techniques to value the building. (5 points)
This is a straight forward present value problem: the required return (discount rate) is applied to
forecasted net cash receipts to convert the forecast to a valuation:
PV
=
1.1
(
1
+
0.12
)
1
+
1.1
(
1
+
0.12
)
2
+
1.1
(
1
+
0.12
)
3
+
1.1
(
1
+
0.12
)
4
+
1.1
+
12
(
1
+
0.12
)
5
¿
$
10.774
million
4

Question 4
A firm with a required return of 10 percent for operations has a book value of net debt of
$2,450 million with a borrowing cost of 8 percent and a tax rate of 37 percent. The firm 's
equity is worth $8,280 million. What is the required return for its equity? (3 points)
WACC = E/V x r
e
+ D/V x r
d
x (1- t)
Required return for equity (
r
e
) = [WACC – D/V x r
d
x (1- t)] / (E/V)
= [10% - 2,450/(2,450+8,280) x 8% x (1-0.37)]/[8,280/(2,450+8,280)]
= 11.47%
Question 5
A.
Estimate the cost of equity capital using the capital asset pricing model (CAPM). (3 points)
(Hint: Market risk premium = Rm – Rf )
By CAPM,
Equity cost of capital = 4.3% + [1.3 × 5.0%] = 10.8%
5

B.
Calculate the cost of capital for operations (WACC). (3 points)
Equity cost of capital = 4.3% + [1.3 × 5.0%] = 10.8%
Debt cost of capital
= 7.5% × (1- 0.36)
= 4.8%
Equity cost of capital
10.8%
Cost of capital for debt
4.8%
(after tax)
Market value of equity
$2,361 million
($40.70 x 58 million)
Net financial obligations
1,750
Market value of operations
4,111
Cost of capital for operations (WACC) =
(
2
,
361
4
,
111
×
10.8%
)
+
(
1
,
750
4
,
111
×
4.8%
)
=
8.25%
6

Part 2. DCF valuation

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- Net Present Value, Generally Accepted Accounting Principles