Spring 1996

Problem 1
Price/BV for AlumCare = 4
P/BV ratio for HealthSoft = 2
If AlumCare's Price is thrice that of HealthSoft,
Let MV of Equity for AlumCare = $ 100.00
Then MV of Equity for HealthSoft = $ 33.33
BV of Equity for AlumCare = $ 25.00
BV of Equity for HealthSoft = $ 16.67
P/BV of Equity after merger = (100+33.33)/(25+16.67) = 3.20

Problem 2
Expected Growth = Net Margin * Sales/BV of Equity * Retention Ratio
.06 = Net Margin * 3* .40
Net Margin = 0.05
Price/Sales Ratio = .05 * (1.06)* .6/(.12 - .06) = 0.53

Problem 3
Unlevered Beta (using last 5 years) = 0.9/(1+(1-.4)(.2)) = 0.80
Unlevered Beta of Non-cash assets = 0.80/(1-.15) = 0.94

Levered Beta for Non-cash assets = 0.94 (1+0.6(.5)) = 1.222

Cost of Equity for Non-cash Assets = 6% + 1.22(5.5%) = 12.71%
Cost of Capital for Non-cash Assets = 12.71%(.667)+.07*.6*(.333)= 9.88%

Estimated FCFF next year from non-cash assets = (450-50)(1-.4)(1.05)-90 = $ 162

Estimated Value of Non-cash Assets = 162/(.0988-.05) = $ 3,320
Cash Balance 500
Estimated Value of the Firm = $ 3,820
- Value of Debt Outstanding = 800
Value of Equity $ 3,020

Fall 1996
Problem 1
After-tax Operating Margin = 0.18
WACC = 13.55% (.6) + 6% (.4) = 0.11
Value/Sales Ratio = .18 (1.05) / (.1053-.05) = 3.42

Value/Sales Ratio of Generic Brand = 3.42 * 0.5 = 1.71

Value of Brand Name = 342 - 171 = 171 million

Part II
a. True; if firms have different risk levels, they will have different PE/g ratios.
(Some of you also pointed out that the growth periods have to be the same. That is true too.

b. Firm B will have the higher Value/EBITDA multiple.

Everything else about the two firms is identical.

c. Price/BV ratio will drop by more than half.

d. P/BV = 2.5
Value of Equity will drop by 30% after special dividend.
Value of Book Value will drop by same dollar amount.
Net Effect = (2.5 * .7) / (1 - .75) = 7

Spring 1997
Problem 1
Expected PE/g ratio for GenieSoft = 2.75 - 0.50 (2) = 1.75
Expected PE/g ratio for AutoPred = 2.75 - 0.50 (1) = 2.25
Actual PE/g ratio for GenieSoft = 50/40 = 1.25
Actual PE/g ratio for AutoPred = 20/10 = 2.00
Both GenieSoft and AutoPred are undervalued relative to the market.

Problem 2
EBITDA $ 550
Depreciation $ 150
EBIT $ 400
EBIT (1-t) $ 240
Next Year
EBITDA $ 578
EBIT $ 420
EBIT (1-t) $ 252
- Reinvestment $ 84
FCFF $ 168
Firm Value $ 4,200

Value/FCFF 25.00
Value/EBIT 10.00
Value/EBITDA 7.27

Problem 3
I would use a higher Value/EBITDA multiple because the comparable firms have a lower return on capital.

Spring 1998
Problem 1
Current PBV = (ROE - g) / (COE - g)
1.5 = (ROE - 5%)/(12%-5%): Solving for ROE = 15.5%
If you add 3% to ROE, ( I also gave full credit if you used 15.5% (1.03))
PBV = (.185-.05)/(.12-.05) = 1.93 1.9286
This assumes that the growth stays the same, but payout ratio goes up
If you had assumed that the payout ratio would remain the same, but growth would change:
Current Payout Ratio = 5/15.5 = 32.26%
New Growth Rate = 0.32 * 18.5% = 5.92%
New PBV = (.185-.0592)/(.12-.0592) = 2.07

Problem 2
Predicted V/S Ratio for Estee Lauder = 0.45 + 8.5 (.16) = 1.81
Predicted V/S Ratio for Generic Company = 0.45 + 8.5 (.05) = 0.875
Difference in V/S Ratios = 0.935
Value of Estee Lauder Brand Name = 0.935 (500) = $ 467.50

Problem 3
Value of Straight Debt portion of Convertible = 12.5 (PVA, 10%, 10 years) = $ 173.19
Value of Conversion Option = 275 - 173.2 $ 101.81

Value of the Firm = $ 1,000.00

Value of Straight Debt = $ 273.19
Value of Equity = $ 726.81
Value of Conversion Option = $ 101.81
Value of Warrants = $ 100.00
Value of Equity in Stock $ 525.00
Value per Share = $ 26.25

Fall 1998
Problem 1
Value of Equity in Common Stock = 50 * $ 20 = $ 1,000.00
Value of Equity in Management Options = 10 * $ 15 = $ 150.00
Value of Conversion Option = 140 - 100 = $ 40.00
Value of Equity = $ 1,190.00

Value of Equity = $ 1,190.00

Value of Debt = $ 150.00
Value of Firm = $ 1,340.00
- Value of Cash = $ 250.00
Value of non-cash assets = $ 1,090.00

Problem 2
a. Firms with high risk and/or low quality projects (ROE) will have low PEG ratios
I would therefore Delphi Systems for my undervalued stock. It has a low PEG ratio, low risk and a high ROE
b. Firms with low risk and high quality projects will have high PEG ratios
I would therefore pick Connectix as my overvalued stock, since it has a high PEG ratio, high risk and a low ROE.

Problem 3
a. Value/FCFF = (1+g)/(WACC - g) = 1.05/(.10-.05) = 21 ! Answer is 20 if you look at Value/FCFF1
(If you assume that the multiple is Value/Current FCFF, this will become (1+g)/(WACC - g) which would yield 21.
b. If the ROC is 12.5%, the reinvestment rate = g/ROC = .05/.125 = 0.40
FCFF = EBIT (1-tax rate) ( 1 - Reinvestment Rate) = EBIT (1-.4)(1-.3)
Value /EBIT = 21 (1-.4) (1-.3) = 8.82 ! Answer is 8.40 if you look at Value/EBIT1

Spring 1999
Problem 1
FCFF on non-cash assets = $ 200 million (1-.4) ( 1 - 4/10) = 72 ! Reinvestment rate = g/ ROC = 4/10
Unlevered Beta for non-cash assets = 1.20/.9 = 1.33333333 ! Reflects the fact that the average firm has 10% debt
Levered Beta for non-cash assets = 1.33 (1 + 0.6(15/85)) = 1.47082353
Cost of Equity for non-cash assets = 6% + 1.47 (5.5%) = 14.09%
Cost of capital for non-cash assets = 14.09% (.85) + 10% (1-.4) (.15) = 12.88%
Value of non-cash assets = 72 (1.04)/(.1288 - .04) = $ 843.24
Value of cash = 250
Value of firm = $ 1,093.24
Problem 2
PE = Payout ratio (1+g)/(r - g)
Payout ratio = PE (r -g)/(1+g)
r = Cost of Equity = 6% + 0.9*5.5% = 10.95%
g = 5%
PE = 10.59
Payout ratio = 10.59(.1095 - .05)/(1.05) = 0.60
g = (1-Payout ratio) (ROE)
.05 = (1 - .6) ROE
ROE = 12.5%

Problem 3
Firm Value = 5000 + 1500 + 1000 = 7500
Firm Value net of cash = 7500 - 1750 = 5750
Taxable Income = 250/(1-.4) = 416.666667 ! Net income includes interest income
Taxable Income before interest income = 291.666667
EBIT = 291.67 + 100 + 80 = 471.67
EBITDA 721.67
Non-cash Value/EBITDA = 5750/722 = 7.96 ! If numerator is non-cash, denominator cannot include interest income
Alternatively,
Firm Value = 5000 + 1500 + 1000 = 7500
EBITDA + Interest Income = 846.67
Value/EBITDA = 7500/847 = 8.85478158

Spring 2000
Problem 1
EBIT at Reliable without auto parts subsidiary = 500 - 200 = 300
EBIT at Chemical products subsidiary = 250
EBIT at Auto Parts Subsidiary = 200

Tax rate = 40%

Reinvestment Rate = (Growth/ROC) = 6%/12% = 50%
Cost of Capital = 10%

Value of Reliable (stand-alone) = 300 (1-.4) (1-.5)(1.06)/(.10-.06) = $2,385 ! Alternatively, we could have valued Reliable on a
Value of Chemical subsidiary = 250 (1-.4)(1-.5)(1.06)/(.10-.06) = $1,988 consolidated basis and subtracted the 50% ofthe auto
Value of Auto Parts subsidiary = 200 (1-.4)(1-.5)(1.06)/(.10-.06) = $1,590 parts subsidiary.
Value of Reliable (with subsidiaries) = 2385 + 0.1 (1988) + 0.5 (1590) = $3,379
Value per share = $33.79

Problem 2
a. will become more sensitive to changes in expected growth rates. (The value of growth is a present value effect)
b. Firm A will have the higher PEG ratio, because it has the lower expected growth rate.
c. Low tax rate, high return on capital, low reinvestment rate: Best possible combination
d. The price to book value ratio will drop. The simplest way to do this is to use the following equation:
PBV = (ROE - growth rate)/(Cost of equity - growth rate)
Inciientally, this is true only if the price to book value ratio is greater than 1, which it is in this case.

e. Enterprise Value = (Market Value of Equity + Market Value of Debt - Cash and Marketable Securities)/(EBIT + DA)
= (150 *10 + 1000-500)/(250+100) = 5.71

Spring 2002
Problem 1
a.
Revenues 1050
EBIT 210
EBIT (1-t) 168
+ Depreciation 105
- Cap Ex 160
- Chg in WC 13 Only the change in working capital matters
FCFF 100
Reinvestment 68 ! I was pretty flexible on how this was computed….
b.
Reinvestment Rate 40.48%
Expected growth rate 5%
Return on Capital = 12.35%
c.
Reinvestment rate 0.5 ! As ROC changes, the reinvestment rate will change. You
Value = 1680 cannot use cashflows from part a.

Problem 2
MV of Equity = 2000
 + Equity Options 100
Value of Equity 2100
+ Debt 1000
- Cash 500
Value of operating assets 2600

Problem 3
a.
PE Ratio for the firm = 32
Expected growth rate = 17.30
b.
PE Ratio = 42.45 ! 12.13 + 1.56 (24) - 3.56 (2)
PEG ratio = 1.76875 ! 42.45/24

Fall 2002
Problem 1
Return on capital on existing assets = 10%
Reinvestment rate = 0.7
a. Expected growth over next 5 years = ROC on new investments * Reinvestment rate + Growth from improved efficiency
= (15%)(.70) +(1+ (.15-.10)/.10)^(1/5)-1
18.95%
b. Portion due to improved efficiency
New Investment growth = 15% *.7 = 10.50%
Growth due to improved efficiency = .1895-.105 = 8.45%

Problem 2
a. Reinvestment rate in perpetuity = g/ rOC = 4/12 = 33.33% ! Don't forget this
Terminal value = 250 (1-.333)/(.09 - .04) = $3,333.33 ! This income is already in year 6. You don't need (1+g)
b. If no excess returns, return on capital = 9%
Reinvestment rate in stable growth = 4/9 = 44.44% ! There are other ways you could solve this problem
Terminal value = 250 (1-.4444)/(.09-.04) = $2,777.78 a. You could make the cost of capital 12%
Value due to excess returns = $555.56 ! 3333-2778 b. You could estimate the present value of the excess returns.

Problem 3
Current PE ratio = 8
Payout ratio = 60%
PE = Payout ratio/ (Cost of equity -g)
8 = .60/(Cost of equity -g) ! You don't need a (1+g) since you have expected income next year
Cost of equity - g = 7.50%
If the riskfree rate rises by 1% and expected growth is unchanged, r -g = 8.5%
PE = .60/(.085) = 7.06

Spring 2003
Problem 1
1 2 3 4 Terminal year
Revenues 650 845 1098.5 1428.05 1470.8915
Op Margin -5% 0% 5% 10% 10%
EBIT -32.5 0 54.925 142.805 147.08915
Taxes 0 0 0 29.122 58.83566 ! Remember to adjust your tax rate to 40% in year 5; NOLs are gone….
EBIT(1-t) -32.5 0 54.925 113.683 88.25349
- Reinvestment $60.00 $78.00 $101.40 $131.82 26.476047 ! Reinvestment in stable growth = g/ROC =3%/10% = 30%
FCFF -$92.50 -$78.00 -$46.48 -$18.14 61.777443
Terminal value $686.42 ! Use the new cost of capital to compute the terminal value
PV -$80.43 -$58.98 -$30.56 $382.09 ! Use a 15% discount rate to discount the cashflows and the terminal value
Value of equity= $212.12 ! Discount back the cashflows at 15%….

Value per share = $15.81 ! (212.12+25)/(10+5) Add the exercise proceeds to the numerator and divide by fully diluted number of shares

Problem 2
a. EV/EBITDA for parent company alone
Market value of equity = 2000
+ Debt 1200
- Cash 300
Enterprise value before adj= 2900
- 5% of Equity of Abigail = 250 ! Subtract out the 5% of market value of equity in Abigail
- 60% of Nuveen equity = 792 ! Minority interest = 240; Book value of equity = 600; Market value of equity = 2.2*600 = 1320
- 100% of Nuveen debt = 300 ! Debt is consolidated; Hence you need to subtract out 100% of Nuveen's debt
Enterprise value after adj = 1558

EBITDA for Hollywood Holdings = 800

- 100% of EBITDA of Nuveen = 400 ! The EBITDA of Abigail does not show up in the parent company but 100% of Nuveen's EBITDA does
EBITDA of parent company = 400
EV/EBITDA = 3.895

Fall 2003
Problem 1
Most Recent 1 2
Revenues $100.00 $120.00 $124.80
EBIT (1-t) $5.00 $12.00 $12.48 You have to estimate the cashflows for next year first and then compute the
- Net Cap ex $6.00 $4.16 terminal value based upon estimated cashflow in year 2.
FCFF $6.00 $8.32
Terminal value $138.67
Value today $131.52

Problem 2
Value of operating assets = 1000
+ Cash & Mkt securities 150 The operating income does not include income from cash holdings. So, you have to add it on. The interest rate is a decoy and does no
+ Minority passive holdings 200 The income from minority passive investments is also not shown in operating income. (it shows up below the operating income line).
- Minority interests 240 The minority interests represent 40% of the Ajax Leasing that you do not own. Since you counted a 100% in your operating income, y
- Debt 400 Debt has to be netted out. Since you are doing a consolidted valuation, it does not matter even if some of this debt belongs to Ajax Le
Value of Equity 710
- Value of options 60 Subtract out the value of the equity options to get to value of common stock.
Value of equity in stock 650
Value per share = 32.5 ! Divide by actual number of shares outstanding

Problem 3
a. PE ratio for Vortex = 12
PEG ratio for Vortex = 1.2
PEG ratio for sector = 1.25
Vortex undervaluation = 4.17% ! (.05/1.20)

b. Vortex may be riskier than the sector. (None of the other explanations are consistent with a lower PEG ratio)

c. ROE = 12%
Payout ratio - first 5 years = 0.16666667 ! Payout ratio = 1 - g/ROE This is the key step. You have to compute the payout ratio first before you can use the equation. I was ver
Payout ratio - perpetuity = 75.00% your algebra.

Fundamental PE = 14.3330844 ! I used the 2-stage model for the PE ratio. You cannot use the stable growth model, since you have high growth.
Fundamental PEG ratio = 1.43330844 ! Divide by the 10% growth rate.
Spring 2004
Problem 1
Total equity value estimated by analyst = 140
+ Value of minority interest = 20
Total firm value estimated by analyst = 160

Analyst asssumed stable growth rate of 3%, cost of capital of 10% and return on capital of 10%
Reinvestment rate assumed by analyst = 0.3 ! G/ROC
Firm value = 160 = FCFF / (.10- .03)
FCFF = 11.2
After-tax operating income = 16 ! FCFF/ (1- Reinvestment Rate)

After-tax operating income at Nova = 4 ! 25% of firm's consolidated operating income

Reinvestment rate for Nova = 0.25 ! Growth rate/ Nova's return on capital
Value of Nova = 60 ! After tax operating income (1 - Reinvestment Rate)/ (Cost of capital - g)
Value of 50% stake in Nova = 30

Springfleld's operating income = 12 ! 75% of firm's consolidated operating income

Springfield's value = 120 ! Use Springfield's cost of capital and reinvestment rate: 12 (1-.3)/(.10-.03)
+ Value of 50% stake in Nova = 30 ! Half of 60 from above
Correct value of equity in Springfield = 150
Corect value of equity per share = 15

Problem 2

a. There were two inconsistent multiples and you got full credit for picking either.
The first was enterprise value/ net income from continuing operations. The word operations here is misleading; what matters is that net income is to equity investors
The second was market value of equity/ cable subscribers ! Subscribers generate revenue for the firm and not just for equity investors
b. Low EV/EBITDA, Low Tax Rate, High ROC
c. Bank A will be able to pay out more of its earnings as dividends since it has a higher ROE. It should have the higher PE.
d. Stocks with very low growth rates will tend to have very high PEG ratios

Problem 3
ROE = 20%
Cost of equity = 12%
Price to Book Ratio = 2

You could also value this company as a dividend discount model

Value of equity = 100 ! Value of stock = 10 *(1-.04/.2)/(.12-.04)
Price to book ratio = 2 ! 100/50

Spring 2005
Problem 1
Current Reinvestment Rate = 50.00% ! (250 - 100 + 50)/400
Current return on capital 8.00% ! 400/5000
Expected growth rate = 30%
(ROC - 8%)/8% + ROC * .50 = 30%
Solve for ROC, ROC = 10%

Problem 2
1 2 3
Net Income 150 165 181.5
FCFE 50 55 60.5
Expected Growth rate in net income = 10.00%
Equity Reinvestment Rate = 66.67% ! 1- FCFE/ Net Income
Return on equity = g/ Reinvestment rate = 15.00%

Growth rate in stable growth = 3%

Equity reinvestment rate in stable growth 20.00% ! G/ ROE
FCFE in year 4 = 149.556 ! 181.5 (1.03) (1-.20)
Terminal value of equity = 2991.12

Problem 3
Market value of equity = 500 ! Since you are given the market value of common
+ Equity options 100 equity, you have to reverse the process (and the signs)
- Cash 150 to get to value of operating assets.
+ Debt 300
Market's assessment of value of operating 750

Problem 4
Value of equity in VRW = 880 ! Value of operating assets + Cash - Debt
Value of equity in Centaur Steel = 620
Value of 60% stake = 372
Total value of equity in VRW = 1252
Fall 2007
Problem 1
1 2 3
Revenues $1,000 $1,030
$1,061 Grading scale -Part
Operating Margin -5.00% 1.00%
5.00% a. Did not use year
EBIT -$50.00 $10.30
$53.05 b. Did not compute
Tax rate 0% 0%40% c. Wrong cost of cap
1 2 3 4 d. Mechanical errors
EBIT -$50.00 $10.30
$53.05 $54.64
EBIT (1-t) -$50.00 $10.30
$47.71 $32.78
Reinvestment 0 0 0 9.83454 ! Reinvestment rat
FCFF -$50.00 $10.30
$47.71 $22.95
Terminal value $327.82 Terminal value cost
PV -$44.64 $8.21 $267.29 ! Dicount back all
Nol $50.00 $39.70 $0.00
Value of firm = $230.86
+ Cash $25.00 Grading scale: Part
- Debt $100.00 a. Used wrong cost o
Value of equity $155.86 b. Cash incorrectely
Value per share = $15.59 c. Debt incorrectly
d. Mechanical errors
Reinvestment Rate = g/ ROC = 3/10 = 30.00%

c. Price of bond = 600

Setting up the problem a. Probability of de
600 = 1000 (1- probability of distress)/ 1.05^3 b. Mechanical errors
Probability of distress = 30.54% c. Value of equity
Value of equity per share = $10.83 ! 15.59*(1-.3054)

Problem 2
a. Value of Zookin's operating assets = 1250 All or nothing
b. Value of equity = 1250 + 250 + 250 = 1750 All of nothing
c. Treasury stock approach = (1750 + 10*5)/ (50+10) = $30.00 Mechancal error: -0.5
d. Overstate the value per share. In the treasury stock appraoch, we value options at exe
Spring 2008
Problem 1
Return on capital = 6.00% ! Failed to estimate reinvestment; -1 point
Expected growth rate = 3%
Cost of capital = 10%

Reinvestment rate = 50.00%

FCFF next year = $9.27 ! I gave full credit even if you missed t
Value of operating assets = $132.43 ! Minority interest miscalculated: - 1 point
+ Cash $25.00 ! Other errors: -0.5 point
- Debt $50.00
- Minority interests $40.00 ! Replace book value of minority interest with estimated ma
Value of equity = $67.43

Prob lem 2
1 2 3
Net Income -10 -5 10
- Reinvestment 10 5 5
= FCFE -20 -10 5
Cost of equity 20% 16% 12%

a. Terminal value
Return on equity = 12% ! Reinvestmeent rate not computed: - 1 pt
Expected growth rate = 4%
Reinvestment rate = 33.33%
Net income in year 4 = $10.40
Reinvestment in year 4 = $3.47
FCFE in year 4 = $6.93
Terminal value of equity = $86.67 ! The reinvestment rate has to be re-estimated with ROE =

b. Value of equity today

 1 2 3
FCFE -$20.00 -$10.00 $5.00 ! No compounded cost of equity: -1 point
Terminal value $86.67
Compounded cost of equity 1.2 1.392 1.55904 ! Use compounded cost of equity since
Present value -$16.67 -$7.18 $58.80
Value of equity today = $34.95
Exercise proceeds = $4.00 ! Exercise price * 2 ! Double counted shares: -1 point
Number of shares = 12.00 ! Includes options but not expected future share ! Did not compute exercise value: -1 point
Value per share = $3.25

Fall 2008
Problem 1
Year Current 1 2 3
Expected growth 8% 8% 8%
EBIT (1-t) $300.00 $324.00 $349.92 $377.91
+ Depreciation $50.00 $54.00 $58.32 $62.99
- Cap Ex $175.00 $189.00 $204.12 $220.45
- Change in WC $75.00 $81.00 $87.48 $94.48
FCFF $100.00 $108.00 $116.64 $125.97

a. Reinvestment rate = 66.67% ! (Net Cap Ex + Change in WC)/ EBIT (1-t)

Growth rate = 8.00%
Return on capital = 12.00%
b.
Reinvestment rate = 33.33% ! g/ ROC ! Cashflows grow 4% a year forever after year 5, but if the return on capital stays at 12%,
FCFF in year 4 = $262.02 ! 377.91 (1.04) (1-.33) the reinvstment rate has to be reestimated.
Terminal value $4,367.00 ! 262.02/(.10-.04) ! Used cash flow in year 3 to growt at 4%: -1 point
c. & d. ! Did not use 10% as discount rate: -0.5 point
FCFF $108.00 $116.64 $4,492.97
Cost of capital 12% 11% 10% ! Discounted at year-specific cost of capital: -0.5 point
Cumulated WACC 1.12 1.2432 1.36752 ! Discount at cumulated WACC ! Mistake on minority interest: -0.5 to -1 point
Present value $96.43 $93.82 $3,285.49 ! Other errors: -0.5 point
Value of firm $3,475.74
+ Cash 400
- Debt 1000 I also gave full credit if you used the treasury stock approach. ! Used weird combinatiions of treasury stock and option
- Minority interest 500 ! 250 * 2 Add exercise value of $ 400 million (20*20 to numerator) approaches: -0.5 to -1 point
Value of equity $2,375.74 and divide by 100 million shares
Value of options 200
Value of equity in common stock $2,175.74
Value per shaer $27.20

e.
False. (The cash wll be discounted only if investstor expect the firm to waste the cash. ! ALL OR NOTHING
This firm has a return on captial > Cost of captial. I would expect investors to trust the
management of this firm.

f.
EBIT (1-t) of diversted stores = $30.00
Cost of capital = 10% ! Estimated a reinvstment even though growth was zero: -0.5 top
Value of stores = $300.00 ! With no growth, we can assume EBIT (1-t) = FCFF ! Did not net out proceeds: -0.5 point
Divestiture proceeds = 250
Net effect on value = -$50.00 ! Sold for less than these stores are worth
Effect on value/share = -$0.63 ! Value per share will decrease

Fall 2009
Problem 1
1 2 3 Terminal year
EBIT -$100.00 $100.00 $150.00 154.5 ! Ignored NOL: -1 point
Taxes $0.00 $0.00 $40.00 61.8 ! Failed to accumulate losses: -0.5 points
EBIT (1-t) -$100.00 $100.00 $110.00 92.7 ! Did not compute FCFF: -1 point
Reinvestment $100.00 $150.00 $50.00 23.175
FCFF -$200.00 -$50.00 $60.00 69.525
Terminal value $993.21
Cumulated Cost of capital 1.1500 1.2880 1.4168 ! Did not cumulate discount rates: -1 point
PV -$173.91 -$38.82 $743.38
NOL $150.00 $50.00 $0.00

Capital invested $572.50 $722.50 $772.50 ! Did not compute ROC in year 3: -1 point
! Errors on reinvestment rate: -1 point
Return on capital in terminal year = 12.00% ! Errors on terminal value computation: -0.5 to -1 point
Reinvestment in terminal year = 25.00%

Value of operating assets = $530.64

+ Cash $80.00 ! Did not add cash: -1 point
+ Value of cross holding $100.00 40*2.5 ! Did not compute minority holding value: -1 point
- Expected lawsuit liability $25.00 ! .25*100 ! Did not subtract out lawsuit liability: -1 point
Value of equity $685.64

Value of equity = $685.64 ! Any mistake: -1 point

+ Exercise proceeds $60.00
/ Number of diluted shares 110
Value per share today = $6.78

Fall 2010
Year 1 Year 2 Year 3
Revenues $150 $160 $180
EBIT (1-t) -$15 $15 $25
+ Depreciation $15 $20 $25
- Cap EX $5 $25 $40
FCFF -$5 $10 $10 Grading notes
Cost of capital 14% 12% 10%
a. PV of cash flows for first 3 years =
Cumulated Cost of capital 1.1400 1.2768 1.4045 ! Discount at ! Did not cumulate: -1 point
Cash Flow -$5 $10 $10 ! In year 3: Math errors: -0.5 point each
Present Value -$4.39 $7.83 $7.12
Total $10.57

b. Return on capital invested

EBIT (1-t) -$15 $15 $25 ! Capital inv ! All or nothing…. Sorry
Capital invested: end of year $180 $185 $200 Capital invested in year n + (Cap ex - Depreciation)
ROC -8.33% 8.11% 12.50% g/ROC will not work, since ROC is changing

c. Terminal value
Return on capital = 12.50% ! Did not compute reinvestment rate: -1 point
Expected growth rate = 3% ! Math errors: -0.5 point each
Reinvestment Rate = 20.0%
Terminal Value 273.333333 ! 25*1.025* (1-0.2)/(.10-.025)

c. PV of terminal value = 194.615326 ! Discount back at cumulated cost ! Used book value of debt: -0.5 point
Sum of FCFF next 3 years $10.57 ! Did not discount terminal value: -0.5 point
Value of opeating assets = $205.18
+ Cash 25
- Debt 75 ! Cannot use book value ina DCF valuation
Value of equity = $155.18
Value per share= $7.76

Problem 2
FCFE value of equity ! Did not compute FCFE value = - 1 point
FCFE = 120 ! Already next year's number ! Did not set up probability of nationalization: -1 point
Cost of equity = 10% ! Other math errors: -0.5 point each
Value of equity = 2000 120/(.10-.04)
Market value of equity 1500 ! Share price * No of shares
Market value of equity =FCFE value (1- Prob of Natl) + 0 (Prob of Natl)
Probability of nationalization 25%

Problem 3
Expected return = 12.000% ! Riskfree rate + beta (Risk premium) ! All or nothing
Fund's expected return = 10%

Value of $ 1 investment = 0.83333333 ! .10/.12

Discount on fund = 16.67%

Problem 4 ! Used book value of miniority interest: -1 point

Value of operating assets = 1500 ! Added minority interest: -1 point
+ Cash 200 ! Added debt or netted out cash: -0.5 each
- Debt 300
- MV of minority interests 240
Value of Equity = 1160

Fall 2011
a.
Expected EBIT (1-t) = 60 ! Did not compute reinvestment: -1 point
Capital invested = 1000 ! Other errors: -0.5 point each
Return on capital = 6%
Cost of capital = 10%

Expected growth rate = 2%

Expected Reinvestment rate = 33.33%
Value of operating assets = 500

b. To value cash,
Assuming that the cash does not get wasted
Probability of happening = 40% ! Did not value cash right under "not wasting" scenario: -0.5 point
Value of cash = 100 ! Did not value cash right under "wasting" scenario: -0.5 to -1 point
Assuming that cash gets wasted on projects making 6% (cost of capit ! Did not apply probabilities: -0.5 point
Probablity of happening = 60%
Value of cash = 60
Expected value of cash = 76

Problem 2
Value of operating assets = 1200 ! Error on valuing minority interests: -0.5 to -1 point
- Estimated value of minority interest 125 ! 25% of Value of subsidiary = 40/(.10-.02) = 500 ! Added option value to value instead of subtracting: -0.5 point
+ Cash 100 ! Adjusted number of shares for options: -0.5 point
- Debt 300 ! Assuming that Lonza has no debt or cash ! Other errors: -0.5 point each
Value of equity 875
- Value of equity options 100 ! Value of options =20 *5 You cannot use the treasury stock approach since you do not have the exercise price of the o
Value of equity in common stock 775 All you have is the value per option.
Value per share = 7.75 ! Divide by 100 million shares

Problem 3
Value of Drake Drugs operating assets = 1000 ! Did not reestimate the growth rate: -1 point (If you use 2% growth and a 20% reinvesment
Expected growth rate = 2% are being internally inconsistent)
Cost of capital = 10% ! Left EBIT (1-t) at pre-adjustment level: -0.5 to -1 point
Imputed FCFF next year = 80 ! 1000 = FCFF next year/ (Cost of capital -g) ! Other errors: -0.5 point each
Imputed Reinvestment Rate= 10.0% ! Growth rate/ ROC

When you capitalize R&D, neither FCFF nor cost of capital should change Some of you did try to back out the EBIT (1-t) from the FCFF
FCFF = 80 Pre-R&D
Cost of capital = 10% EBIT (1-t) = 88.8888889 ! 80.9
The R&D does affect the reinvestment rate and ROC Reinvestment 8.88888889
Reinvestment rate = 20.00% FCFF 80
Return on capital = 12.50% Post R&D adjustment
Expected growth rate = 2.50% EBIT (1-t) - 88.89 + Current year's R&D - R&D amortization
Reinvestmetn8.89 + Current year's R&D - R&D amortization
Corrected value of operating assets= 1066.66667 FCFF 80
Value increases by $66.67 million

Fall 2012
Problem 1 Grading templage
1 2 3 4 5
Revenues (in millions) ### ### ### ### ### 1. Error on NOL carry forward: -1 point
Pre-tax Operating margin -3.00% -1.00% 2.00% 5.00% 8.00% 2. Error on reinvestment number: -1 point
EBIT ($30.60) ($10.40) $21.22 $54.12 $88.33 3. Other errors: -0.5 point each
Taxes 0 0 0 $1.74 $35.33
EBIT (1-t) ($30.60) ($10.40) $21.22 $52.38 $53.00
Reinvestment $10.00 $10.20 $10.40 $10.61 $10.82
FCFF ($40.60) ($20.60) $10.82 $41.77 $42.17

NOL at end of year ($60.60) ($71.00) ($49.78) $4.34 $92.67

Problem 2
Let the intrinsic value of the operating assets be X

Value of Operating assets X 1. Value of the operating assets wrong: -1 point

+ Cash 100 2. Did not compute reinvestment rate: -1 point
Value of firm 1300 3. Other errors: -0.5 point each
- Debt 300
Value of equity 1000
- Value of options 100
Value of shares traded 900

Solving for X
Value of operating assets 1200

1200 = After-tax OI (1- 2%/20%) / (.10-.02)

Solving for After-tax OI $106.67 ! Full credit if you put (1+g) in here and solved

Problem 3
Approach 1: Value June parent and add 60% of value of Vellum
Juno (consVellum Juno (Parent)
Operating income (after-tax) $110 $20 $90 1. Computed ROC using book equity alone: -1 point
Book Equity $1,000 $100 $900 2. Did not compute reinvestment rate: -1 point
Debt $225 $50 $175 3. Mixed up add/subtract minority holding/interest: -1 point
Cash $100 $25 $75 4. Did not compute equity value of sub: -0.5 point
5. Other errors: -0.5 point each
Invested Capital $125 $1,000
Return on capital 16.00% 9.00% ! Full credit even if you did not net out cash
Expected growth rate 2.00% 2.00%
Reinvestment Rate 12.50% 22.22%
Cost of capital 10.00% 10.00%
Value of business 218.75 875
+ Cash $25 $75
- Debt $50 $175
Value of equity $194 $775

Value of equity in Juno = 775 + 0.6 (194) = $891.25

Value of equity per share = $8.91

Approach 2: Value June consolidated and subtract out 40% of equity value in Vellum (minority interests)

Juno (consVellum
Operating income (after-tax) $110 $20
Book Equity $1,000 $100
Debt $225 $50
Cash $100 $25

Invested Capital $1,125 $125

Return on capital 9.78% 16.00%
Expected growth rate 2.00% 2.00%
Reinvestment Rate 20.45% 12.50%
Cost of capital 10.00% 10.00%
Value of business 1093.75 218.75
+ Cash $100 $25
- Debt $225 $50
Value of equity $969 $194

Value of equity in Juno = 969 - 0.4 (194) = $891.25

Value of equity per share = $8.91

Spring 2013
Problem 1 Grading template
1 2 3 4 5 1. Wrong return on capital in year 5 = -1 point
Revenues $500 $750 $1,000 $1,200 $1,250 2. Did not discount back to present or used wrong discount factor: -1 point
Operating Income after taxes $10 $23 $35 $40 $50 3. Other math errors: -1/2 point
Reinvestment $30 $25 $25 $20 $20
FCFF -$20 -$3 $10 $20 $30
Cost of capital 12% 11% 10% 9% 8%
Invested capital $410 $435 $460 $480 $500
Return on capital 2.44% 5.17% 7.61% 8.33% 10.00%
Reinvestment rate = 30.0%
Terminal value = $721.00
Discount factor for year 5 1.60984454 ! (1.12)(1.11)(1.10)(1.09)(1.08)
Present value of terminal value $447.87

Problem 2
Limca (Paren LightEat
Value of the operating assets $1,500.00 $600.00 1. Did not value Limca correctly: -1 point
Debt $500.00 $300.00 2. Did not reflect value of LightEat: -1 point
Cash $200.00 $100.00 3. Math errors: -1/2 point
Number of shares 100.00 50.00
Value of equity (independent) $1,200.00 $400.00
Value of equity with cross holdings $1,500.00
Value of equity per share = $15.00

Problem 3
Market value of equity = 600 1. Did not compute reinvestment rate: -1 point
+ Debt 250 2. Used wrong value of operating assets: -1 point
- Cash 100 3. Math errors: -1/2 point
Value of operating assets 750
Cost of capital 9%
Growth rate 3%
Reinvestment rate = 33.33%
750 = AT Op Inc (1- .33)/ (.09-.03)
After-tax operating income $67.50
After-tax operating margin 6.75% ! If you use (1+g), answer = 6.55%

Problem 4
Value with existing management = $250.00
Return on capital (existing) = 5.00% 1. Error on status quo valuation: -1 point
Return on capital (new) = 10% 2. Error on optimal valuation: -1 point
New reinvestment rate = 20.0% 3. Did not compute return on capital for status quo: -1 point
Value with new management = $333.33 4. Math error: -1/2 point
Expected value = $283.33

Fall 2013
Problem 1 Grading Guideline
Current Revenues = $10.00
Current Invested Capital = $5.00
Current Sales to Capital = 2.00
1 2 3
Expected revenues $40.00 $75.00 $100.00 1. Sales to Capital ratio incorrect: -/2 to 1 point
Pre-tax Operating Income -$10.00 $10.00 $30.00 2. Taxes incorrect: -1 point
NOL at start of year 20 $30 20 3. Reinvestment incorrect: -1 point
Taxes paid 0 0 $3
After-tax Operating Income -$10 $10 $28
- Reinvestment $15.00 $17.50 $12.50
FCFF -$25.00 -$7.50 $15.00
Invested Capital $20.00 $37.50 $50.00
Pre-tax return on capital -50.00% 26.67% 60.00%

Problem 2
After-tax operating income $25.00 1. Did not compute reinvestment: -1 point
Expected growth rate = 2% 2. Value of the firm incorrect: -1/2 to -1 point
Return on capital = 10% 3. Did not deal correctly with TrueSmoke equity value: -1 point
Reinvestment Rate 20.0% 4. Dealt with options incorrectly: -1 point
Expected FCFF = $20.00
Cost of capital = 7%
Enterprise Value = 400
- Net Debt 100
- 25% of TrueSmoke Equity 50
Value of equity = 250
- Value of options 25
Value of common stock 225
Number of shares 25
Value per share $9.00

Problem 3
Value of Domino Media = 500 1. Incorrect value estimate for going concern: -1 point
- Debt 350 2. Errors getting from firm value to equity value: -1 point
+ Cash 50 3. Error in backing out probability of default: -1 point
Value of equity 200
Value per share (going concern) = 20
Price per share = 15 ! Value per share (going concern) (1- Prob (Default)) + Value per share (default) (Prob Default)
Probability of bankruptcy 25% ! 15 = 20 (X) + 0(1-X)

Fall 2014
Problem 1 Grading template
Base year 1 2 3 Year 4 (and beyond)
1. Used after-tax OI as FCFF: -2 points
Expected growth 6.00% 6.00% 6.00% 3.00% 2. Used RR from first 3 years as terminal RR: -1.5 points
EBIT (1-t) $100.00 $106.00 $112.36 $119.10 $122.67 3. Error on computing ROC: -1 point
- Reinvestment $40.00 $42.40 $44.94 $47.64 4. Used FCFF from year 3 as earnings: -1/2 point
FCFF $60.00 $63.60 $67.42 $71.46
Reinvestment rate = 40.00%
Expected growth rate = 6.00%
Return on capital = 15.00%

In year 4
Expected growth rate = 3%
Return on capital = 15.00%
Reinvestment rate = 20.0%

EBIT (1-t) = $122.67

- Reinvestment = $24.53
FCFF $98.14

Terminal value = $1,962.79

Problem 2
PV of FCFF Cash Debt 1. Errors on computing equity values: -1/2 each
Xena (consolidated) $1,500.00 $300.00 $500.00 2. Subtracted Clio value instead of adding: -1 point
Clio $750.00 $200.00 $150.00 3. Added Minority Interest instead of subtracting: -1 pont
Lomax $1,000.00 $100.00 $200.00 4. Other errors: -1/2 to -1 point

Approach 1: Value as separate companies

Equity valOwnershipValue of ownerships
Xena (parent) $500.00 $200.00 $300.00 $400.00 100% $400.00
Clio $750.00 $200.00 $150.00 $800.00 25% $200.00
Lomax $1,000.00 $100.00 $200.00 $900.00 75% $675.00
Value of equity in Xena $1,275.00

Approach 2: Value consolidated & net out minority interests

Xena (consolidated) $1,500.00 $300.00 $500.00 $1,300.00 100% $1,300.00
Clio $750.00 $200.00 $150.00 $800.00 25% $200.00
Net out minority interests (25%) of Lomax $1,500.00
Lomax $1,000.00 $100.00 $200.00 $900.00 25% $225.00
Value of equity in Xena $1,275.00

Problem 3
 Most recent 1 2 3
Net Income $100.00 $110.00 $121.00 $133.10 1. Computed reinvestment from ROE: -1 point
Regulatory capital $1,000.00 $1,050.00 $1,102.50 $1,157.63 2. Math errors: -1/2 point
Change in regulatory capital $50.00 $52.50 $55.13
FCFE $60.00 $68.50 $77.98
ROE 10.48% 10.98% 11.50%

Terminal value calculation

Net Income in year 4 = 137.093 1. Used FCFE from year 3 as earnings: -1/2 point
ROE in year 4 = 11.50% 2. Did not compute ROE: -1.5 points
Expected growth rate = 3% 3. Error on computing ROE: -1 point
Payout ratio in year 4 = 73.91% 4. Computed book value of equity: -1.5 points
FCFE in year 4 $101.32
Terminal value = $2,026.45

Spring 2015
Problem 1 Grading template
PV of blockbuster drug at the end of year $7,606.08 1. PV of blockbuster drug incorrect: -1/2 point to -1 point
PV of blockbuster drug today = $4,722.78 2. Did not discount back 5 years: -1/2 point
Probability that it will be approved = 60% 3. Did not adjust for probability of failure: -1/2 point
Value of company today = $2,833.67 4. Other math errors: -1/2 point
Number of shares = 100
Value per share = $28.34

Problem 2
Intrinsic value of operating assets = 500
+ Cash 50 ! No discount because company earns its costs of capital
- Debt 100 ! Only interest bearing debt. Don't double count accounts payable
- Expected lawsuit payout 40 ! 25% of $160 million
- 20% of Electra Retail 80 ! Counted entire value in your DCF
Value of equity 330 1. Did not add cash: -1/2 point
- Value of equity options 10 2. Wrong debt subtracted (or missed); -1/2 point
Value of equity in common stock 320 3. Lawsuit dealt with incorrectly: -1/2 point
Number of shares outstanding 70 4. Minority interest incorrectly dealt with: -1 pont
Value per share = $4.57 5. Wrong adjustment for equity options: -1/2 to -1 point
(I gave full credit for the treasury stock approach, where you add the exercise
Problem 3
Base 1 2 3 Terminal year
Revenues $500.00 $525.00 $551.25 $578.81 $596.18
EBITDA Margin 2.50% 5.00% 10.00% 20.00% 1. Did not track NOL correctly: -1/2 to -1 point
EBITDA $12.50 $26.25 $55.13 $115.76 2. Did not estimate EBIT correctly: -1/2 to -1 point
DA $40.00 $40.00 $40.00 $40.00 3. Did not add back DA: -1/2 point
EBIT $27.50 $13.75 $15.13 $75.76 $77.28 4. Did not adjust for WC correctly: -1/2 point
Taxes $0.00 $0.00 $14.86
EBIT(1-t) $13.75 $15.13 $60.91
+ DA $40.00 $40.00 $40.00
- Cap Ex $0.00 $0.00 $0.00
- Chg in WC $10.00 $10.00 $10.00
FCFF $36.25 $65.13 $110.91
Terminal Value $579.58
NOL $40.00 $53.75 $38.63 $0.00
Tax savings 0 $6.05 $9.95
PV at 12% $4.82 $7.08

Terminal value
Reinvestment rate = 0.25 1. Did not recompute CF in terminal year: -1 point
EBIT (1-t) in terminal year = $46.37 2. Did not compute reinvestment rate correctly: -1/2 to -1 point
FCFF in terminal year = $34.77 3. Math errors: -1/2 point each
Terminal value = $579.58

Value of NOL = $11.91 See above ! If you were withing shooting distance of $16 milion: -1/2 point
If you ended up within shooting distance of $40 million: -1 point
If you ended up with values greater than $40 million: -1.5 point
of the excess returns.
NOLs are gone….

nd the terminal value

The interest rate is a decoy and does not play a role in the valuation.
s up below the operating income line). Add estimated market value = 80 *2.5
ed a 100% in your operating income, you have to subtract estimated market value: 120* 2
f some of this debt belongs to Ajax Leasing

ore you can use the equation. I was very, very easygoing about

have high growth.

ment; -1 point

ted: - 1 point

mputed: - 1 pt
uity: -1 point

value: -1 point

fic cost of capital: -0.5 point

erest: -0.5 to -1 point

ns of treasury stock and option

even though growth was zero: -0.5 top -1 point
 do not have the exercise price of the options.

use 2% growth and a 20% reinvesment rate, you

ng/interest: -1 point
sed wrong discount factor: -1 point
status quo: -1 point
2 point to -1 point

-1/2 to -1 point
approach, where you add the exercise value of $20 million and divide by 75 million shares)
orrectly: -1/2 to -1 point

of $16 milion: -1/2 point

ce of $40 million: -1 point
n $40 million: -1.5 point