Assignment #3, Solutions
FIN 503
Problem 1: Payout policy
Clearwater Inc. is going to pay a dividend of D1 = $5.00 per share next year and dividends will then
increase at a 5% annual rate forever (D2
Body Shape
I+A3:E34nput Data
Sales
COGS/Sales
OP EX/sales
Interest rate
Tax Rate
Dividends
Curr Assets/Sales
Curr Liab/sales
Fixed Assets
Starting equity
Numbers in Thousands
Income Statement
Sales
CO
Risk and Return
Expected Return on TD Stock = ?
What is an expectation (expected
value)?
A likely or representative outcome:
Midterm Score ( Zi
)
Probability ( pi )
100
95
80
70
60
p1
p2
p3
p4
p5
2
FIN 503
Company Valuation III
Outline
FTE (flow-to-equity) method
Excess return models
Relative valuation
Other issues in valuation
2
Flow-to-Equity Method
Flow-to-Equity (FTE) Method
Value of equity
FIN 503
Company Valuation II
Outline
APV approach
Continuation value
2
APV Method
The valuation of a firm is done in two steps:
Value of firm as if the firm is fully-equity financed
Add the value
FIN 503
Payout Policy
Outline
Payout Policy
Dividends
Share repurchases
Payout policy and value
Taxes and dividends
Different theories that explain payout policy
Clientele theory
Signaling the
FIN 503
Cross-border Valuation
Outline
Issues specific to cross-border
valuation
Valuation of projects/firms with
foreign currency cash flows
Country risk
Case: Globalizing the Cost of Capital at
FIN 503
Company Valuation I
Outline
Overview of firm valuation approaches
Forecasting accounting statements
Body Shop case
Cash flow calculations
Free cash flows (FCF)
Free cash flows to equity
FIN 503
Estimating the Cost of Capital
Outline
Cost of debt
Debt value (D)
Cost of debt (rD)
Cost of equity
Equity value (E)
Cost of equity (rE)
Calculating cost of capital
2
Overview
Example
FIN 503
Capital Structure in a Perfect
Market
Outline
Definitions
Does capital structure matter?
M&M Proposition I
Leverage and financial risk
M&M Proposition II
Levered and unlevered betas
2
Ca
FIN 503
Company Valuation: Free and
Residual Cash Flows
Outline
Overview of firm valuation approaches
Forecasting accounting statements
Body Shop case
Cash flow calculations
Free cash flows (FCF)
FIN 503
Capital Structure: Taxes, Financial
Distress, and Agency Costs
Outline
Capital structure matters
Debt and taxes
Costs of bankruptcy and financial
distress
Agency costs/benefits of leverage
FIN 503
Estimating the Cost of Capital
Outline
Cost of debt
Debt value (D)
Cost of debt (rD)
Cost of equity
Equity value (E)
Cost of equity (rE)
Calculating cost of capital
2
Overview
Example
FIN 503
Company Valuation 4: An Example
Outline
Multiples approach
Business plan
Financial model
Cost of capital
Continuation value
Company valuation
2
Multiples Approach
Consider Ideko Corporation,
FIN 503
Company Valuation: WACC and
APV Method
Outline
Firm valuation under constant debt-equity
ratio
WACC method
APV method
FTE (flow-to-equity) method
Advanced topics
Project with different r
FIN 503
Real Options
Capital Budgeting with DCF
Using NPV rule in capital budgeting
Forecast projects expected future cash
flows
Discount cash flows at discount rate
reflecting
Time value of money
FIN 503
Company Valuation: Multiples
Valuation using Multiples
This sounds like a fancy valuation method, but it is
actually just a short-cut (less accurate) valuation
method.
Idea: comparable firms
FIN 503
Company Valuation: Estimating
Continuation Value
A Simplified Approach to Estimating
Continuation Value
Firm value =
PV(FCF) of forecast period
+ PV of Continuing value
FCF
Continuation valu
FIN 503
Company Valuation IV
Real Options
Capital Budgeting with DCF
Using NPV rule in capital budgeting
Forecast projects expected future cash
flows
Discount cash flows at discount rate
reflecting
FIN 503
Capital Structure: Perfect Markets
Outline
Definitions
Does capital structure matter?
M&M Proposition I
Leverage and financial risk
M&M Proposition II
Levered and unlevered betas
2
Capit
FIN 503
Capital Structure: Taxes, Financial
Distress, and Agency Costs
Outline
Capital structure matters
Debt and taxes
Costs of bankruptcy and financial
distress
Agency costs/benefits of leverage
FIN 503
Practice Problem: Free Cash Flows and WACC
A friend of yours is a consultant specialized in performance-based compensation. The times in
the consulting business are currently pretty bleak, whi
Assignment #4, Solutions
FIN 503
Problem 1: Mergers and acquisitions
As CFO of Fashion Inc. you are investigating the possible acquisition of Style Inc. You have the
following basic data:
Expected ear
Assignment #4
FIN 503
Due on April 8 Hand in only one solution per group
Problem 1: Mergers and acquisitions
As CFO of Fashion Inc. you are investigating the possible acquisition of Style Inc. You hav
Assignment #2, Solutions
FIN 503
Today is January 1, 2015. You are interested in evaluating Slender, the maker of weight-loss yoghurt, as a
potential acquisition target. You collected the following in
Assignment #2
FIN 503
Due on February 11 Hand in only one solution per group
Today is January 1, 2015. You are interested in evaluating Slender, the maker of weight-loss yoghurt, as a
potential acquis
FIN 503
Capital Structure in a Perfect
Market
Outline
Definitions
Does capital structure matter?
M&M Proposition I
Leverage and financial risk
M&M Proposition II
Levered and unlevered betas
2
Ca
Income Statement
(numbers in $1,000; * indicates forecasted numbers)
Sales
Cost of Goods Sold
Gross Profit
Selling, General & Administrative Expense
EBITDA
Depreciation
EBIT
Interest Expense
Pretax in