FSA_Assignment_5_Solution-3.docx - FINC6316 Financial Statement Analysis Assignment#5 Solution(Total 51 points possible Worth 10 of final grade Name

FSA_Assignment_5_Solution-3.docx - FINC6316 Financial...

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FINC6316 Financial Statement Analysis Assignment #5 Solution (Total 51 points possible, Worth 10% of final grade) Name: ____________________________________________
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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
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V = 1,000,000 / (0.10 – 0.03) = 14,285,714 3
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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
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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
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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
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Part 2. DCF valuation
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