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Please answer the following by today. Chapter 7 Questions 1 ABC Incorporated shares are currently trading for $30 per share. The firm has 1.

Please answer the following by today. Please would appreciate your help.

Chapter 7 Questions

1         ABC Incorporated shares are currently trading for $30 per share. The firm has 1.4 billion shares outstanding. In addition, the market value of the firm's outstanding debt is $2.3 billion. The 10-year Treasury bond rate is 6.45%. ABC has an outstanding credit record and has earned an AAA rating from the major credit rating agencies. The current interest rate on AAA corporate bonds is 6.75%. The historical risk premium for stocks over the risk-free rate of return is 5.2 percentage points. The firm's beta is estimated to be 1.2 and its marginal tax rate, including federal, state, and local taxes is 40%.

a.              What is the cost of equity?

b.             What is the after-tax cost of debt?

c.              What is the cost of capital?

2         No Growth Incorporated had operating income before interest and taxes in 2011 of $250 million. The firm was expected to generate this level of operating income indefinitely. The firm had depreciation expense of $12 million that same year. Capital spending totaled $15 million during 2011. At the end of 2010 and 2011, working capital totaled $60 and $70 million, respectively. The firm's combined marginal state, local, and federal tax rate was 40% and its debt outstanding had a market value of $1.5 billion. The 10-year Treasury bond rate is 5.5% and the borrowing rate for companies exhibiting levels of creditworthiness similar to No Growth is 8%. The historical risk premium for stocks over the risk free rate of return is 5.2%. No Growth's beta was estimated to be 1.2. The firm had 2,500,000 common shares outstanding at the end of 2011. No Growth's target debt to total capital ratio is 35%.

a.  Estimate free cash flow to the firm in 2011.

b.  Estimate the firm's cost of capital.

c.  Estimate the value of the firm (i.e., includes the value of equity and debt) at the end of 2011, assuming that it will generate the value of free cash flow estimated in (a) indefinitely.

d.  Estimate the value of the equity of the firm at the end of 2011. 

e.  Estimate the value per share at the end of 2011.

3         The following information is available for two different common stocks: company A and Company B. 

Company A Company B

Free cash flow per share in the current year $1.30 $6.00

Growth rate in cash flow per share 10% 3%

Beta 1.5 .7

Risk-free return 6.5% 6.5%

Expected return on all stocks 14.5% 14.5%

a.              Estimate the cost of equity for each firm.

b.             Assume that the companies' growth rates will continue at the same rate indefinitely. Estimate the per share value of each companies common stock.


4         Financial Corporation wants to acquire Great Western Inc. Financial has estimated the enterprise value of Great Western at $110 million.  The market value of Great Western's long-term debt is $20 million, and cash balances in excess of the firm's normal working capital requirements are $5 million.  Financial estimates the present value of certain licenses that Great Western is not currently using to be $5 million. Great Western is the defendant in several outstanding lawsuits. Financial Corporation's legal department estimates the potential future cost of this litigation to be $4 million, with an estimated present value of $3.0 million. Great Western has 4 million common shares outstanding. What is the value of Great Western per common share?

Chapter 8 Questions

5           Siebel Incorporated, a non-publicly traded company, has 2009 after-tax earnings of $25 million, which are

expected to grow at 6 percent annually into the foreseeable future. The firm is debt-free, capital spending equals the firm's rate of depreciation; and the annual change in working capital is expected to be minimal. The firm's beta is estimated to be 2.5, the 10-year Treasury bond is 5 percent, and the historical risk premium of stocks over the risk-free rate is 6.0 percent. Publicly-traded Rand Technology, a direct competitor of Siebel's, was sold recently at a purchase price of 10 times its 2009 after-tax earnings, which included a 25 percent premium over its current market price. Aware of the premium paid for the purchase of Rand, Siebel's equity owners would like to determine what it might be worth if they were to attempt to sell the firm in the near future. They chose to value the firm using the discounted cash flow and comparable recent transactions methods. They believe that either method provides an equally valid. Estimate of the firm's value.

             a What is the value of Siebel using the DCF method?

             b What is the value using the comparable recent transactions method?

             c What would be the value of the firm if we combine the results of both methods?      

6         Best's Foods is seeking to acquire the Heinz Baking Company, whose shareholders equity and goodwill are $45 million and $9 million, respectively. A comparable bakery was recently acquired for $450 million, 35 percent more than its tangible book value (TBV). What was the tangible book value of the recently acquired bakery? How much should Best's Foods expect to have to pay for the Heinz Baking Company? Show your work.

7         Acquirer Incorporated's management believes that the most reliable way to value a potential target firm is by averaging multiple valuation methods, since all methods have their shortcomings. Consequently, Acquirer's Chief Financial Officer estimates that the value of Target Inc. could range, before an acquisition premium is added, from a high of $700 million using discounted cash flow analysis to a low of $550 million using the comparable companies' relative valuation method. A valuation based on a recent comparable transaction is $680 million. The CFO anticipates that Target Inc.'s management and shareholders would be willing to sell for a 25 percent acquisition premium, based on the premium paid for the recent comparable transaction. The CEO asks the CFO to provide a single estimate of the value of Target Inc. based on the three estimates. In calculating a weighted average of the three estimates, she gives a value of .4 to the recent transactions method, 3 to the DCF estimate, and .3 to the comparable companies' estimate. What it weighted average estimate she gives to the CEO? Show your work.

8         Acquirer Company's management believes that there is a 70 percent chance that Target Company's free cash flow to the firm will grow at 25 percent per year during the next five years from this year's level of $4 million. Sustainable growth beyond the fifth year is estimated at 5 percent per year. However, they also believe that there is a 30 percent chance that cash flow will grow at half that annual rate during the next five years and then at a 3.5 percent rate thereafter. The discount rate is estimated to be 14 percent during the high growth period and 11 percent during the sustainable growth period for each scenario. What is the expected value of Target Company?

Chapter 10 Questions

9         Based on its growth prospects, a private investor values a local bakery at $850,000. She believes that cost  savings having a present value of $40,000 can be achieved by changing staffing levels and store hours.

Based on recent empirical studies, she believes the appropriate liquidity discount is 25 percent. A recent transaction in the same city required the buyer to pay a 6 percent premium to the asking price to gain a controlling interest in a similar business. What is the most she should be willing to pay for a 50.1 percent stake in the bakery?

10        You have been asked by an investor to value a restaurant. Last year, the restaurant earned pretax operating income of $350,000. Income has grown 5% annually during the last five years, and it is expected to continue growing at that rate into the foreseeable future. The annual change in working capital is $30,000, and capital spending for maintenance exceeded depreciation in the prior year by $20,000. Both working capital and the excess of capital spending over depreciation are projected to grow at the same rate as operating income. By introducing modern management methods, you believe the pretax operating income growth rate can be increased to 7% beyond the second year and sustained at that rate into the foreseeable future.

            The ten-year Treasury bond rate is 6%, the equity risk premium is 6.5%, and the marginal federal, state,

and local tax rate is 40%. The beta and debt-to-equity ratio for publicly traded firms in the restaurant industry are 2.5 and 2.0, respectively. The business's target debt-to-equity ratio is 1, and its pretax cost of borrowing, based on its recent borrowing activities, is 8%. The business-specific risk premium for firms of this size is estimated to be 6.5%. The liquidity risk premium is believed to be 18%, relatively low for firms of this type due to the excellent reputation of the restaurant. Since the current chef and the staff are expected to remain after the business is sold, the quality of the restaurant is expected to be maintained. The investor is willing to pay a 13% premium to reflect the value of control.

  1. What is free cash flow to the firm in year 1?
  2. What is free cash flow to the firm in year 2?
  3. What is the firm's cost of equity?
  4. What is the firm's after-tax cost of debt?
  5. What is the firm's target debt-to-total capital ratio?
  6. What is the weighted average cost of capital?
  7. What is the business worth? 


           (Note: The first two terms represent the PV of the firm's operating cash flows before the application of modern management methods is fully implemented; the third term is the terminal value and reflects the anticipated sustained improvement in cash flows when the benefits of the new management techniques are fully realized.)


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