Spring 1999

Problem 1
VS = AT Operating Margin * (1- Reinvestment Rate) * (1 + g)/(WACC - g)
Reinvestment Rate = g / ROC = g / (AT Operating Margin * Sales/Capital)
Let the margin for Generic Office be x,
VS for Generic Office = 1.5 = x (1-.05/2x)(1.05)/(.10-.05)
Solve for x,
x = (1.5*.05+(.05/2)*1.05)/1.05
x= 9.64%
HK's after-tax operating margin = 9.64% (1.05) = 10.13% ! I also gave full credit if you added 5% to get 14.64%
HK's VS ratio =.1013 (1-.05/2*.1013)(1.05)/(.10-.05) = 1.6023

Problem 2
a. Value of Developed Reserves = 100,000 * (300-200) * (PV of Annuity, 5 years, 9%) =
b. Value of Undeveloped Reserves (on DCF basis)
Value of oil in the ground = 40,000 * (300-200) * (PV of Annuity, 9%, 12.5 years) =
Value of oil in the ground allowing for development lag = 29,309,311/1.08 =
Fixed cost of development =
DCF Value of Undeveloped reserves =
I also gave full credit for a number of variations, including
a. Assuming that costs and prices are in present value dollars, in which case the value of reserves is [500000*(300-200)]/1.08 = 46,296,296
c. Inputs for Option Pricing Model
y = Annual Production Revenue/Reserves = 40,000/500,000 = 8.00%

S = PV of reserves discounted back by development lag = $ 27,138,251

K = Upfront Cost of Developing Reserves = $ 50,000,000
t = Period for which firm has rights = 15
Variance = Expected variance in ln(gold prices) = 0.09
r = Riskfree rate = 6.00%

d. The developed reserves will become less valuable, since oil prices are down.
The undeveloped reserves may become more or less valuale depending upon whether the effect of S or the effect of variance is greater on the option value.
gave full credit if you added 5% to get 14.64%
! Note that if you do not adjust the reinvestment rate, you
get 1.575.

$ 38,896,513

$ 29,309,310.89 ! 40000 barrels a year for 12.5 years

$ 27,138,250.82
$ 50,000,000.00
$ (22,861,749.18)

6,296,296

! Many of you used 1/15. You actually lose more because

your production potential is much higher.
! Full credit also for $ 46,296,296

! Use forward looking variance

eater on the option value.

Problem 1
Adjusted EBIT = 1500- 100 = 1400
Adjusted EBIT (1-t) = 840
- Reinvestment = 336
FCFF 504 Tax rate = 480/1200 = 40% (Do not divide b
will result in a double counting of the interes
Total Beta = 0.80/0.5 = 1.6 which is already being counted in the cost of
Levered beta = 1.6 (1 + (1-.4)(3/7)) = 2.01142857
Cost of Equity = 6% + 2.01 (4%) = 14.04% Use total beta rather than illiquidity discount,
Cost of Capital = 14.04% (.7) + 7% (1-.4)(.3) = 11.09% insufficient information for such a discount.

Value of private firm = 504 (1.05)/(.1109-.05) = $ 8,692.51

Problem 2
Present Value of FCFF from developed reserves = 300 (PVA,10 years, 9.375%) $ 1,894
Cost of Capital = 12%(25/40) + 5% (15/40) = 9.38%
Value of undeveloped reserves = 4000 - 1894 = $ 2,106 ! Do not subtract from the value

Problem 3
d1 = -0.15 N(d1) = 0.4404
d2= -0.90 N(d2) = 0.1841

Value of Equity = 400 (.4404) - 800 exp (-.06*6) (.1841) = $ 73.41

Value of Debt = 400 - 73.41 $ 326.59
Interest rate on debt = (800/326.59)^(1/6) - 1 = 16.08%
Default spread on debt = 16.08% - 6% = 10.08%
1200 = 40% (Do not divide by EBIT. That
ouble counting of the interest tax benefit
being counted in the cost of capital)

ather than illiquidity discount, since you have

mation for such a discount.

o not subtract from the value of equity.

Problem 1
BigName NoName Brand Name
After-tax Margin 12% 6% ! ROC = After-tax operating margin *
Sales/ Capital 2 2 ! Reinvestment rate = g/ ROC
ROC 24.00% 12.00%
Reinvestment rate 16.67% 33.33%
Value/Sales 2.08 0.832
Value 10.4 4.16 6.24

Problem 2
Net Income 2 ! Remember to subtract after-tax expense = 2.6 - 1(1-.4)
ROE 20.00%
Total Beta 2.75
PBV = 1.94
MV of Equity = 19.4

Problem 3
S= 106.698524
K= 131.698524
t= 12
Variance = 0.0225
Riskless rate = 5%
cost of delay= 0.08333333 ! I think you can also make a reasonable case for 1/8 if you arg
that competition would kick in after the 8th year.
! In fact, you can even make a reasonable case for it being 0. If
0 and want to justify it, give me your reason…
ax operating margin * Sales/BV of capital
rate = g/ ROC

= 2.6 - 1(1-.4)

ase for 1/8 if you argued

case for it being 0. If you entered

Problem 1
First, clean up the market value of equity for the cross holdings
Total market value of equity = 3000 ! 150 *20
- Value of equity in Coleman Holdings = 500 ! 20% of 2500
- Value of equity in Silicon Tech = 1200 ! 60% of 2000
Value of Equity in Steel business = 1300

Next clean up the debt for the consolidated debt from Silicon
Value of debt = 2000
- Value of Debt in Silicon Tech = 500 ! Silicon Tech's debt is consolidated in balanc
Value of debt in Steel business = 1500

Finally, clean up the EBITDA

Consolidated EBITDA = 700
- EBITDA of Silicon Tech = 300
EBITDA of Steel Business = 400

EV of Steel Business = 2800

EV/ EBITDA of Steel Business = 7.00

Problem 2
a. Estimated PS in year 5 = 3.5 ! Net margin = 10%; 1.5 + .2 (10) = 3.5
Estimated Equity value in year 5 = 1750 ! 3.5 * 500
b. Total beta = 2.25
Cost of equity = 14.00%
c. Value of equity today (going concern) = $908.90 ! 1750/1.14^5
Survival adjusted equity value = $363.56 ! 908.90 * .40
debt is consolidated in balance sheet

10%; 1.5 + .2 (10) = 3.5

Problem 1
a. Unlevered beta = 1
Total beta = 2.5
Cost of equity = 15.00% ! Use total beta because buyer is not diversified
Return on capital = 0.175 ! 280/1600
Reinvestment rate = 0.22857143 !4%/17.5%

EBIT (1-t) $280.00

- Reinvestment $64.00 ! 22.86% of EBIT (1-t)
FCFF $216.00

Value of firm = $2,042.18 ! 224 (1.04)/(.15-.04)

b. Unlevered beta = 1! IPO valuation: use market beta

Cost of equity = 9.00%
Return on capital= 0.15 ! Using reestimated return on capital
Reinvestment rate = 0.26666667 ! 3.5%/15%
EBIT (1-t) $240.00 ! Reestimate operating income with 40% tax rate
- Reinvestment $64.00 ! 23.33% of 240
FCFF $176.00

Value of firm = $3,660.80 ! 176 (1.04)/(.09-.04)

c. There should be an illiquidity discount in the private transaction but not on the IPO.

Problem 2
Part a
Value of commercial product = $88.63
Value of R&D = $45.00
Total = $133.63

Market value of firm = $240.00

Value of patent = $106.37

Part b
If the firm develops the patent today, you will replace the option value above with the NPV
NPV = $49.39
Change in value = -$56.98 ! 49.39 - 106.37
New firm value = $183.02 ! 240 - 56.98
Problem 1
a. Intrinsic price to book ratio = 0.83333333 ! (ROE - g)/ (COE -g); ROE =8%, Cost of equity = 5+4%
Stock is undervalued slightly.
b. if the market is correct
Price to book ratio = .8 = (.08-.03)/(r-.03)
Solving for r, Cost of equity = 9.25%

Problem 2
Levered beta = 1.56
EV/Sales based upon regression= 2.028 ! 0.30 + .08 (15/100) - 1.2 (1.56) + .12 (20)
Actual EV/Sales ratio = 2.5 ! (200 + 100 -50)/100
Stock is overvalued by 23.27% ! Divided the actual by the expected value

Problem 3
Total beta = 3! Sale in a private transaction. Divided beta by correlation.
Cost of equity = 17.00% ! 5% + 3*4%
Reinvestment rate = 0.4 ! G/ROC = 4%/10%
Status quo value of firm = $ 6.92 ! 1.5 (1-.4)/(.17-.04); I don't need a (1+g) because 1.5 is
Value of 25% stake in firm = $ 1.73

With a doubled return on capital

Reinvestment rate = 0.2 ! Doubled return on capital only on new investments. So e
Optimal firm value = $ 9.23 ! 1.5 (1-.2)/(.17-.04)
Value of 51% stake in firm = $ 4.71

For IPO valuation

Market beta = 0.9
Cost of equity = 8.600% Since this is an IPO valuation, y
Status quo value = $19.57 ! 1.5 (1-.4)/(.086-.04)
Optimal firm value = $26.09 ! 1.5 (1-.2)/(.086-.04)
Value per non- voting share = $4.89
Value per voting share = $5.54 !4.89+.2(26.09-19.57)/2
8%, Cost of equity = 5+4% = 9%)

1.56) + .12 (20)

pected value ! You cannot compare the predicted value to the average for the sector. That tells you very little.

. Divided beta by correlation.

need a (1+g) because 1.5 is next year's income

nly on new investments. So existing operating income unaffected

nce this is an IPO valuation, you have to revalue the company with a market beta.
or. That tells you very little.
Problem 1
Gloria Inc. Generic Brand Name Value
After-tax Operating Margin 0.15 0.075
Return on Capital 0.25 0.125
Reinvestment Rate 0.2 0.4
EV/Sales 2.4 0.9
Enterprise Value $ 2,400.00 $ 900.00 $ 1,500.00

Problem 2
Cost of equity = 10.0% ! Use market beta since this is for initial public offering
Part a. Under existing management
EBIT (1-t) $ 5.00
Return on capital = 0.1
Reinvestment Rate = 0.4 ! 4./10
Value of firm = $ 50.00 ! No surprise here. If you earn your cost of capital, MV = BV

Part b. Under new management

EBIT (1-t) $6.50
Return on capital = 13.00%
Reinvestment Rate = 30.77% ! 4/13
Value of firm = $75.00

Value of control = $5.00 ! (100 - 75) *.20

Value per non-voting share = $10.00 ! Divide status quo value by total number of shares
Value per voting share = $12.50 ! Add Value of control/ Number of voting shares
for initial public offering

your cost of capital, MV = BV

tal number of shares

r of voting shares
Problem 1
EV/Sales = After-tax operating margin ( 1- g/ ROC)/ (Cost of capital - g)
1.20 = .10 (1 -.04/ ROC)/ (.09 - .04) ! There are other ways to get to the same s
Solving for return on capital, we get 3000 = 250 (1-.04/ROC)/ (.09-.04)
Return on capital = 10.00% ! While technically you do not need a (1+g
I did give full credit to those who used it.
Problem 2
Bank PBV ROE
Hibernia Bank 1.25 16%
Bancomer 1.1 14%
North Fork Bank 0.9 12%
North Fork Bank is the most
undervalued bank…..

If we use the regression, PBV Predicted PBV

Hibernia Bank 1.25 1.2 Overvalued
Bancomer 1.1 1.1 Correctly valued
North Fork Bank 0.9 1 Under valued

b. Low Price to book, high ROE, low risk, high growth

Problem 3
Corrected income = $300,000.00 ! Subtracted out rent (75,000), accounting
After-tax income= $180,000.00 Why subtract out the dentist salary? If you
practice for something that does not belong
Total beta = 2.4 ! 0.80*3 business. You could be a non-dentist, buy
Cost of equity = 13.85%
! On the total beta calculation, I did give fu
Value of practice = $1,549,367.09
r ways to get to the same solution. You could set up firm value
04/ROC)/ (.09-.04)
ly you do not need a (1+g) in the numerator since I have given you next year's operating income
edit to those who used it.

rent (75,000), accounting expense (25,000) and dental salary of 150,000.

t the dentist salary? If you don't, you will be paying a premium to the owner of the
ething that does not belong to him. Another way to think of this is as a pure
ould be a non-dentist, buy this business and hire a dentist to work for you for 150,000…..

ta calculation, I did give full credit if you assumed that the R squared was 33% and took the square root of it.
square root of it.
Problem 1
a. Tax Rate: The higher the tax rate, the lower the EV/EBITDA multiple should be (not higher)
b.
EV/EBITDA = 2.26 + .1513 (Tax Rate) + .2156 (Return on Capital) – .1335 ! You cannot change the s
EV/EBITDA = 7.9059

Problem 2
Market value fo equity = 1800
Net Income next year = 1500

MV of Equity/ Forward Earnings = 1.2 ! 1800/1500

PE =1.2 = Payout Ratio / (.10 - .04) ! Cost of equity = 10%; Growth rate = 4%
Payout ratio = 7.20%
Return on equity = g/ (1- Payout ratio) = 4.31% ! Loser company but dem's the breaks…

Problem 3
Total Beta = 1.2/.4 = 3 ! Market beta/ Square root of R squared
Cost of equity = 5% + 3*4% = 17.00%
Reinvestment rate = 0.25 ! G/ ROC
Value of firm = $66.21

Cost of equity to publicly traded firm = 0.098 ! Investors in publicly traded firm are diversi
new return on capital = 0.18 ! I also gave full credit if you adjusted the gr
New reinvestment rate = 0.16666667
Value of firm = $ 151.47 ! Only the growth rate or reinvestment rate w
Value of 51% = $ 77.25 Existing operating income remains unchange
 not higher)

You cannot change the sign on a regression coefficient if you don't agree with it.

wth rate = 4%

y but dem's the breaks…

blicly traded firm are diversified.

credit if you adjusted the growth rate upwards to 4.5%

h rate or reinvestment rate will be affected….

ng income remains unchanged.
Problem 1
Enterprise value = Equity + Debt - Cash
2500
EV/Sales = 1.25 ! 2500/2000

b. Estimated ROC = 0.075 ! Assumed book equity = 1000

b. If the market value is right,
EV/Sales = Expected operating margin next year/(1-RIR) (Cost of capital -g)
1.25 = 0.075(1- .03/.075)/ (Cost of capital - .03) ! After-tax Margin = 150/2000
Solving for the cost of capital,
Cost of capital = 6.60% ! If you assume a 5% return on capital, this number will b

Problem 2
Market value of equity of parent company = 650 ! 1000*10 - 0.1*500 -0.75*400
Debt of parent company = 300 ! 500 -200
Cash of parent company = 50 ! 150 - 100
Enterprise value of parent company = 900
EBITDA of parent company = 150 ! 250 -100
EV/EBITDA for parent company = 6! 900/150

Problem 3
C. Best combination: Low P/BV, Low risk, High growth, High ROE

b. Expected price to book for company A = 0.8

Actual price to book ratio = 1.25
Company is overvalued by apprroximately 36.00%

c.
PBV of C = 1.2 = 0.80 + 0.75 X - 0.5 (1)
Solving for X
ROE for company C would have to be 12%
The ROE would have to be approximately 12%… it is actually 20%
 ! The book value of capital was missing on this problem. So, I gave full credit to any book
value of capital that was rasonable. The solution assumes that the book value of equity
is $ 1 billion and the book value of capital is $ 2 billion.

on capital, this number will be lower (5.4%)

000*10 - 0.1*500 -0.75*400 ! Did not net out cash of consolidated sub: -0.5 point
! Got parent EBITDA incorrect: -0.5 to -1 point
! Other computational errors: -0.5 point each

! One point for D and F. They were close but failed one one dimension (D on growth and F on risk)

! Mechanical errors: -0.5 point

! Used intrinsic equation: -1 point

! Set up equation in way to make solution impossible: -1 point
! Mechanical erorrs: -0.5 point
 ! Did not use any reinvestment: -0.5 point (No ROC would support this)
! Reinvestment rate wrong (given your ROC): -0.5 point
! Failed to consider operating margin: -0.5 point
! Other mechanical errors: -0.5 point each

h and F on risk)
Problem 1
Current price to book ratio = 1.5 Used wrong cost of equity
Current cost of equity = 9% Math error: -0.5 point eac
Expected growth rate= 3%
PBV = 1.5 = (ROE -g)/ (Cost of equity -g)
1.5 = (ROE -.03)/ (.09-.03)
ROE = 12%

b. New ROE incorrect: -1 po

Book equity increases by = 20% New cost of equity incorre
New return on equity = 10.00% ! Old ROE/ (1 + Capital increase)
New cost of equity= 11% ! Riskfree rate + New ERP
New price to book ratio = 0.875 ! (10%-3%)/(11%-3%)

Problem 2
Company Primary sharePrice/Share Net Income # Options Value/option
Zap Tech 100 $20 $100 10 $10
InfoRock 500 $6 $150 80 $1.50
Lo Software 80 $5 $20 20 $0.50

Market Cap Net Income PE Ratio Diluted EPS Diluted PE

Zap Tech $2,000 $100.00 20.00 $0.91 22.00
InfoRock $3,000 $150.00 20.00 $0.26 23.20
Lo Software $400 $20.00 20.00 $0.20 25.00
Lo Software is the cheapest stock. It's modified PE ratio is the lowest.

Problem 3
Value of private firm = 2000 Used EBIT (1-t) as FCFF:
EBIT (1-t) next year = 300 Reinvestment rate wrong:
Reinvestment rate = 20% ! g/ ROC = 3/15 = 20% Math errors: -0.5 point ea
FCFF next year = 240

To solve for the cost of equtiyt used: ! Market beta computation

Value of firm = 2000 = 240/ (r - .03)
Cost of capital = Cost of equity = 15%
Cost of equity = 15% = 4% + Beta (5%)
Total beta used = 2.2
Market beta = 1.1 ! Total beta * Correlation with the market
Cost of equity = 4% +1.1*5% = 9.50%
Correct value of the firm = $ 3,692.31 ! 240/ (.095-.03)
ed wrong cost of equity: -0.5 point
th error: -0.5 point each

w ROE incorrect: -1 point

w cost of equity incorrect: -1 point

Using regular PE completely misses the options oustanding: -2 points

Using diluted PE treats all options as equal: -1 point

Total Equity Modified PE

$2,100 21.00
$3,120 20.80
$410 20.50

ed EBIT (1-t) as FCFF: -1 point

nvestment rate wrong: -0.5 point
th errors: -0.5 point each

Market beta computation wrong: -1 point

Problem 1
Part a
Return on capital = 0.15 ! Aftertax operating margin* Sales/Bv oF Capital
Reinvestment Rate = 0.2 ! g/ ROC
EV/Sales Ratio = 1.333333333 ! AT Oprating Margin (1-RIR)/ (Cost of capital -g)
Part b
New Return on Capital = 0.16 ! 0.08 *(1.5*1.3333)
Reivestment Rate = 0.1875
EV/Sales Ratio = 1.083333333
New EV = 1.444440833 ! Remember that revenues are higher by 33.33%
Value of the firm increaases by about 8.33%

Problem 2
SunTrust SouthEast
Market value of equity $150.00 $100.00
Book Value of equity $90.00 $80.00
Expected Net income next year $18.00 $12.00
P/BV 1.666666667 1.25
ROE 20.00% 0.15

If SunTrust Bank is fairly valued,

P/BV = 1.6667 = (.20-.03)/(Cost of equity -.03)
Cost of equity = 0.132

Valuing SouthEast Bank with this cost of equity

Intrinsic P/BV = 1.17647059
Actual P/BV = 1.25
Overvalued by 6.25%

Problem 3
Expected EBIT(1-t) 170 ! 200 - 50 (1-.4)
Reinvestment rate = 0% ! Because growth is zero
Value to undiversifed investor = 850
Cost of equity to undiversified investor = 20.00%
Impliws Total Beta = 2.666666667
Correlation with the market = 40%
Market beta = 1.066666667
Cost of equity = 10.400%
Value of business = $ 1,634.62
Sales/Bv oF Capital !Did not compute return on capital: -1 point
! Math errors: -1/2 point
/ (Cost of capital -g)

! Did not recompute sales/cap ratio: -1/2 poitn

! Did not recompute value: -1/2 point

e higher by 33.33%

! Wrong cost of equity: -1 point

1 Did not compare to actual P/BV: -0.5 point

! After-tax operating income wrong: -1 point

! Did not compute correct cost of equity: -1 point
! Did not adjust for market beta: -1 point
Problem 1
Current EV/Sales Ratio = 1.7 ! Ignored reinvestment rate
Reinvestment Rate= 0.15 ! Growth rate/ ROC 1 Math errors: -0.5 point ea
EV/Sales = After-tax margin (1-RIR)/ (Cost of capital -g)
1.7 = After-tax margin (1-.15)/(.09-.03)
After-tax margin = 12.00%

After-tax margin (Generic) = 6.00%

Current sales/capital = 1.67 ! ROC/After-tax margin of Slim Joe's
Return on capital (Generic) = 10.00%
Reinvestment rate = 0.3
EV/Sales ratio 0.70

Problem 2
Lugano Stulz
Market value of equity 9000 13000 ! EV computed incorrectly:
Book value of equity 4000 6000 ! EBITDA computed incorre
+ Market value of debt 5000 5000 ! Did not consider ROC or ta
Book value of debt 4500 4500
- Cash 1500 2000
- Market value of minority holdings 1500 1000
Book value of minority holdings 500 500
+ Market value of minority interests 1000 3000
Book value of minority interests 400 1000
Tax rate 40% 20%
Net Income 600 1200
Interest expenses 500 500
EBIT 1500 2000 ! Net Income/ (1-t) + Interest expenses
DA 500 1000

EV = 12000 18000 ! MV Equity + MV Debt - Cash - MV Mino

EBITDA 2000 3000 ! EBIT +DA
EV/Ebitda 6.00 6.00
ROC= 12.86% 18.82%
Since Stulz has a hgher ROC, lower tax rate and trades at the same multiple, it is cheaper.

Problem 3
PBV = (ROE-g)/(Cost of equity -g)
For publicly traded firms
1.6 = (.12-.04)/ (Cost of equity -.04)
Cost of equity = 9.00%
Given riskfree rate = 4% and ERP =5%
Beta = 1
Total beta = 2.5 ! Beta/ 0.4
Cost of equity = 16.50%

PBV ratio of Seacrest = 1.28

gnored reinvestment rate = -1 point
Math errors: -0.5 point each

! Did not recompute return on captial: -1 point

! Math errors: -0.5 point each

V computed incorrectly: -0.5 to -1.5 points

BITDA computed incorrectly: -0.5 to -1 point
id not consider ROC or tax rate in making judgment: -0.5 point

1-t) + Interest expenses

V Debt - Cash - MV Minority Holdings + MV Minority Interests

! Did not solve correctly for beta: -1 point

! No total beta computation: -1 point
! Math errors: -0.5 point each
Problem 1
a. Intrinsic PE = 0.60/(.08-.02) = 10 ! All or nothing (Ok if you use
b.
Estimated value for equity = $ 1,000.00
- Value of options $ 50.00 ! 10*5 !Used diluted number of shar
Value of equity in common stock $ 950.00 !Did not subtract out value o
Value per share $ 9.50 ! 950/100 ! Did not divide by actual num

Problem 2 KMD RAD holdings KMD just steel

Value of equity = $ 9,000.00 $ 3,000.00 $ 6,000.00 ! Net out 60% of market valu
Debt $ 5,000.00 $ 3,000.00 $ 2,000.00
Cash $ 2,000.00 $ 1,000.00 $ 1,000.00
EBITDA $ 2,100.00 $ 700.00 $ 1,400.00

Enterprise Value $ 7,000.00

EV/ EBITDA 5.00
The steel business is fairly valued.

Problem 3
Corrected after-tax EBIT 50
After-tax Operating margin = 0.05
Total Beta = 3 ! 1.2/0.4
Expected growth = 0.1
Estimated EV/Sales = 0.5
Estimated EV = $ 500.00
ll or nothing (Ok if you use (1+g) and get 10.2…)

sed diluted number of shares = -1.5

d not subtract out value of options = -1 point
id not divide by actual number of shares: -1 point

! EBITDA for steel business wrong: -1 point

et out 60% of market value of RAD ! Equity value of steel business wrong: -1 point
! Added minority interest or subracted it : -1 point
! Other errors: -0.5 point each

! Did not adjust margin correctly = -1 point

! Did not get total beta = -1 point
! Other errors: -0.5 to -1 point
Problem 1
Business EBIT DA Invested CapiMedian EV/EBITDA for sector
Real estate $150 $50 $500 $6
Travel $35 $5 $240 $10
Spa services $100 $20 $600 Not available

a. Grading template
Market value of equity = 2200 ! Did not compute curren
+ Debt 800 ! Did not compute EV of
- Cash 500
Enterprise value = 2500
- EV of real estate 1200
- EV of Travel 400
EV of Spa Services 900
EBITDA of Spa Services 120
EV/EBITDA 7.5

b.
Cost of capital = 8% ! Return on capital incorr
Expected growth rate = 2% ! Ignored reinvestment:
Return on capital = 10% ! 100 (1-.4)/600 ! Other errors: -0.5 poin
Reinvestment rate = 20.0%
Intrinsic EV = 816 ! Gave full credit if you got 800 (no (1+g)
Intrinsic EV/EBITDA = 6.8
The business is overvalued at 7.5 times EBITDA

Problem 2
With patent Without patent
Operating margin 15% 7.50% ! Did not back out margi
Return on capital 25% 10% ! Did not compute reinve
Expected growth rate 3% 3% ! Other errors: -0.5 poin
Cost of capital 9% 10%
EV/Sales 2.2 0.75
To solve for the current after-tax margin,
EV/Sales = 2.2 = After-tax margin (1- .03/.25)/(.09-.03)
After-tax operating margin = 15.00%

Problem 3
Forward PE ratio for public firms 12.5 ! Did not back out implie
Cost of equity of public firms = 9.00% ! 3% + 1 (6%) ! Did not compute total b
Expected growth rate = 3.00% ! Did not compute reinve
Implied ROE = 12.00% ! 12.5 = (1- .03/ROE)/ (.09-.03) ! Other math errors: -0.5

To value private firm

Total beta = 3.33333333 ! 1/.30, since buyer is undiversified
Cost of equity = 23.00%
ROE = 0.24 ! Twice public company ROE
Expected growth rate= 3%
Reinvestment rate = 0.125
PE = 4.375
Value of equity = $87.50 ! 20*4.375
DA for sector

ading template
id not compute current EV correctly: -0.5 point
id not compute EV of businesses correctly: -0.5 point

eturn on capital incorrect: -0.5 point

gnored reinvestment: -1 point
ther errors: -0.5 point each

id not back out margin from existing EV/Sales: -1 point

id not compute reinvestment: -1 point
ther errors: -0.5 point each

id not back out implied ROE correctly: -1 point

id not compute total beta: -1 point
id not compute reinvestment: -1 point
ther math errors: -0.5 point
Problem 1
Sales EBITDA EBIT Net Income BV of equity
Farm Equipment $10,000 $1,500 $1,000 $400 $3,000
Financing $2,000 $650 $650 $100 $1,000
Entire firm $12,000 $2,150 $1,650 $500 $4,000
For farm equipment business
Return on capital = 13.33% Grading template
Expected growth rate = 3% 1. Used pre-tax return on capital: -1/2 p
EV/EBITDA = 5.90983333 2. Math error on regression equation: -1
EV = $8,864.75 3. Incorrect ROE: -1/2 point
4. Math error on regression equation: -1
For financial service arm 5. Used wrong cash in equity value com
Return on equity = 10.00% 6. Used wrong debt in equity value com
Expected growth rate = 3%
PBV ratio = 1.2
Estimated value of equity= $1,200

Overall equity value

EV of farm equipment = $8,864.75
+ Cash $500
- Debt $2,000
Value of equity in farm equipm $7,364.75
+ Value of equity in financing $1,200
Value of equity in firm $8,564.75
Value per share $10.71

Problem 2
ROE = 12.50% 1. Did not set up to solve for ROE : -1 p
Cost of equity = 10% 2. Did not correct for BV of equity chang
Stable growth rate = 2.50% 3. Math errors: -0.5 point each

Trading PBV= 0.9 (I gave full credit even if you read the q
If PBV = 0.90 = (ROE - .025)/(.10-.025) The PBV ratio then becomes 1.33*0.9 =
Imputed ROE = 9.25% The increase in invested capital is small
Increase in BV of equity = 35.14%

Problem 3
1 2 3 4 5
Revenues $5.00 $7.50 $10.00 $12.00 $12.50
After-tax operating income $2.50 $0.75 $1.25 $1.80 $2.00
FCFF $0.05 $0.25 $0.50 $0.90 $1.20
Terminal value $21.46
Beta 3 3 2 2 1.2
Cost of equity 21.00% 21.00% 15.00% 15.00% 15.00%
Cumulated cost of equity 1.2100 1.4641 1.683715 1.93627225 2.22671309
PV $0.04 $0.17 $0.30 $0.46 $10.18
Value of firm/equity $11.15
Part b
Cost of equity 10.20% 10.20% 10.20% 10.20% 10.20%
PV $0.05 $0.21 $0.37 $0.61 $13.94
Value of firm/equity $15.18
Offering price $14.00
Value gained $1.18
 BV of Debt Cash Cost of equity Cost of capital
$2,000 $500 9% 7.50%
$3,000 $500 8% 6.20%
$5,000 $1,000 8.80% 7.00%

return on capital: -1/2 point (Gave full credit if you did not net out cash)
regression equation: -1/2 point
E: -1/2 point
regression equation: -1/2 point
ash in equity value computation: -1/2 point
ebt in equity value computation: -1/2 point

p to solve for ROE : -1 point

ct for BV of equity change: -1 point
-0.5 point each

t even if you read the question as 90% of intrinsic value.

en becomes 1.33*0.9 = 1.197
nvested capital is smaller then, about 8.7%

1. Did not compute correct costs of equity: -1 point

2. Did not use compounded cost of equity: -1/2 point
3. Terminal value wrong: -1/2 point

10.20% 1. Did not compute correct cost of equity: -1 point

2. Did not compute change in value: -1 point
3. Math errors: -1/2 point
Problem 1
Market value of equity = 1000
Market value of debt = 250
Debt to capital ratio = 20%
Cost of capital = 9.00%

EV/Invested Capital = 1.25

Expected growth rate = 3%
Return on capital = 10.500% EV/IC = (ROC -g)/ (Cost of capital -g)

If the firm earns its return on capital

EV/Invested Capital = 1
Estimated EV = 1000
- Market value of debt = 250
Value of equity = 750 Many of you compared the enterprise value of 1
Equity is overvalued by (1000-750)/750 = 33.33% you need to subtract out debt.

Problem 2
Return on equity = 12.50%
Market value of equity = 6000
Book value of equity = 4000
PBV ratio = 1.5

PBV =0.145+7 (.125)+6*X

Solving for X
Reg Cap/ Risk Adj Assets = 0.08
Risk adjusted assets = 50000

After sale of mortgage bank

Net Income 300
Book value of equity = 2000
Return on equity = 0.15
Risk adjusted assets 20000
Reg Cap/ Risk adj assets 0.1
Price to Book ratio = 1.795
Market value of equity = 3590
Value per share = $11.97

Problem 3
Expected CF next year = 10
VC's value for the firm = 100
Expected growth rate = 3%
Imputed cost of capital = 13%
Imputed Beta (for VC) = 2
Market Beta = 1.2
Cost of capital = 9.00%
Value of firm in IPO = $166.67
 ! EV to Inv Cap ratio wrong: -0.5 point
! Equation for EV/Inv Cap wrong: -1 point
! Other math errors: -0.5 point

! Error on estimated EV: -0.5 point

! Did not subtract out debt: -0.5 point
(Computed percentage under or over pricing on Enterprise value)
mpared the enterprise value of 1250 to the estimated EV of 1000, but
tract out debt.

! ROE incorrect: -0.5 point

! PBV equation set up incorrectly: -0.5 point
! Error on backing out ratio: -.5 point

! Did not adjust net income: -0.5 point

! Did not adjust book value of equity: -1 point
! Did not adjustt risk adjusted assets: -0.5 point
! Did not estimate new market value of equity: -1 point

! Did not estimate back out cost of capital: -1 point

! Error on getting VC beta: -1 point
! Error on computing new market beta: -1 point
Problem 1
Step 1: Compute the cost of capital for generic snack companies
EV/Sales = 1.8
Return on capital = 12.00% ! After-tax Operating Margin * Sales/Capital
Reinvestment Rate = 25.00% ! g/ ROC
EV/Sales = After-tax Operating Margin * (1-Reinvestment Rate)/ (Cost of capital -g)
1.80 = .08 (1-.25)/(Cost of capital -.03)
Cost of capital = 6.33%
Step 2: Compute the EV/Sales ratio for Moana Foods
After-tax operating margin 16.00%
Return on capital = 24.00%
Reinvestment Rate = 12.500%
EV/Sales = 4.20
Step 3: Compute the proportion due to brand name value
EV/Sales (Generic) = 1.8
EV/Sales (Moana Foods) = 4.20
Brand name effect = 2.4
Brand name % of value = 57.14%

Problem 2
Next year's Expected
Revenues EBITDA
Best-fit regression
growth(using comparable companies in se
Technology $1,000 $400 15.00% EV/Sales = 1.25 + .5(EBITDA
Hotels $2,000 $200 4.00% EV/EBITDA= 3.30 +42.5(EBIT
Corporate Expenses $0 $75 2.50%

Predicted EV/Sales for technology = 3.25

Predicted EV/EBITDA for hotels = 8.75

Revenues EBITDA Predicted EV

Technology $1,000 $400 $ 3,250.00
Hotels $2,000 $200 $ 1,750.00
Corporate Expenses $0 $45 -$ 900.00
Overall Enterprise value = $4,100

Actual Enterprise value = $4,600.00

Don't break up the company. The broken up EV is lower than the consolidated EV.

Problem 3
Private retailerPublic retailer
Correlation with the market NA 0.45
Return on equity 20% 10%
Expected growth rate 2.50% 2.50%
Illiquidity Discount 15% NA

Payout ratio 87.5% 75.0%

PE for public company = Payout ratio/ (Cost of equity -g)

15 = .75/(Cost of equity -.025)
Cost of equity = 7.50%
Beta for public company = 0.9
Beta for private company = 2
Cost of equity for private company = 13.00%
PE for private company = .875/(.13-.025) = 8.3333
PE after illiquidity discount = 7.0833
* Sales/Capital

comparable companies in sector)

/Sales = 1.25 + .5(EBITDA/Revenues) + 12.0 (Expected Growth Rate)
/EBITDA= 3.30 +42.5(EBITDA/Revenues) + 30.0 (Expected Growth Rate)
Problem 1
Assets Liabilities
Cash $100 Debt $200
Other current assets $150
Fixed assets $650
Equity $800
Equity investment in Caligula (10%
owned) $100
Total Assets $1,000 Total $1,000

Part a
Invested Capital = $800 ! Debt + Equity - Cash - Equity Investment in Caligula
Enterprise value = $1,200 ! Debt + MV of equity - Cash - MV of Equity Investmen
EV/Invested Capital = 1.50

Part b
EV/Invested Capital = (ROC -g)/ (Cost of capital -g)
Cost of capital = 8.00%
Expected growth rate = 2.00%
Return on capital = 11.00%

Problem 2
Division Revenues EBITDA Net Income BV of Equity
Steel $800 $200 $80 $300
Chemicals $600 $200 $120 $200
Finance $600 $350 $100 $250
Total Company $2,000 $750 $300 $750

Division EBITDA/SalesEstimated EV/Estimated EV

Steel 25.00% 2.00 $1,600
Chemicals 33.33% 2.50 $1,500
Total $3,100
- Debt of divisions $500
Value of equity in divisions $2,600
ROE PBV Estimated Equity Value
Financing 40.00% 4.00 $1,000

Total value of equity = $3,600

Value per share = $24.00

Problem 3
Comparable (public) companies
Expected
cash flow
Company Business next year Market Beta Correlation with market
Sigma Inc. Technology $80.00 0.8 0.4
Precision Mfg. Manufacturin $25.00 0.8 0.2
Risk free rate = 2.00%
Equity Risk Premium = 5.00%
As stand alone companies to undiversified owners
Company Expected cashTotal Beta Cost of equityValue
Sigma Inc. $80.00 2.00 12.00% $800.00
Precision Mfg. $25.00 4.00 22.00% $125.00
Total $925.00
As a combined company to you
Combined businesses $105.00 1.6 10.0% $1,312.50
Premium over stand alone values = $387.50
As % of value = 41.89%
 Grading Template

1. Enterprise value wrong: -1/2 to -1 point

ty Investment in Caligula (BV) 2. Invested capital wrong; -1/2 to -1 point
- MV of Equity Investment in Caligula (20% of 750)

1. Did not set up EV/Inv Cap ratio correctly: -1.5 points

2. Math errors: -1/2 point each

Debt (Book & Market)

$200
$300
$500
$1,000

1. Steel business EV wrong: -1/2 point

2. Chemical business EV wrong: -1/2 point
3. Financial Services business Equity Value wrong; -1/2 point
4. Did not subtract right debt: -1 point
5. Math errors: -1/2 point each

rrelation with market

1. Values of stand alone companies wrong: -1/2 point each
2. Did not compute total beta for combined company: -1 point
3. Value of combined company wrong: -1/2 point
4. Math errors: -1/2 point each
y: -1.5 points

wrong; -1/2 point

-1/2 point each

d company: -1 point
Problem 1
CommerzBank SunClaims
Net Income $ 80 $ 120
Book Value of Equity $ 500 $ 1,000
Price to Book Ratio NA 1.25
Return on equity 0.16 0.12
Price to Book Ratio for SunClaims = 1.25 = (.12-.02)/(Cost of equity -.02)
Cost of equity = 0.1
Price to Book Ratio for CommerzBank 1.75
Estimated Market Value for Equity = $ 875

Problem 2
Most Recent year In year 5
Revenues $ 50 $ 1,000
EBITDA $ (30) $ 80
Debt Outstanding $ - $ 500
Expected growth rate in revenues 80% 15%

Expected EV/EBITDA in year 5 = 25 !=13+80*.15

Expected Enterprise Value in year 5 = $ 2,000 ! 80*25
- Expected Debt in year 5 = $ 500 ! You have to subtract debt from FV
Expected Value of Equity = $ 1,500
Value of equity today = $ 602.82 ! Discount back 5 years at 20%

Problem 3
Steel Hotels Corporate
Revenues $ 1,000 $ 1,500 $ -
EBITDA $ 150 $ 300 $ (50)
EBIT (1-t) $ 75 $ 150 $ (30)
Cost of capital 8.00%
Steel Hotels Estd Value
Peer Group EV/EBITDA 6.00 8.00
Estimated EV $ 900.00 $ 2,400.00 $ (500.00)

Problem 4
Return on capital = 20.00% ! 10/50
Reinvestment Rate = 10.00% ! g/ROC
EBIT (1-t) next year $ 10.00
FCFF next year $ 9.00

Market Beta = 1.20

Total Beta = 2.00
Cost of equity = 14.00%
Value of business = $ 75
- Illiquidity Discount $ 15
Value to private buyer = $ 60
 Grading Template

1. Did not solve for cost of equity: -1 point

2. Did not use right PBV set up: -1 point
3. Did not compute ROE correctly: -1/2 point
4. Used net income as cash flow: -1 point
5

1. Used current year's expected growth rate: -2 points

2. Error In estimating EV/EBITDA: -1/2 point
3. Did not subrtact out debt from forward EV: -1 point
4. Did not discount back to today: -1 point

btract debt from FV

5 years at 20%

1. Did not price steel business correctly: -1/2 point

2. Did not price hotel business correctly: -1/2 point
3. Did not value corporate correctly: -1 point
4. Math errors: -1/2 point

$ 2,800.00

1. Did not compute reinvestment rate: -1 point

2. Did not comptue total beta: -1 point
3. Forgot illiquidity discount: -1/2 point
4. Math errors: -1/2 point each
Problem 1
Papillon Bank Average French Bank
Price to Book NA 1.5
Return on Equity 15% 12%
Expected Growth Rate (in perpetuity) 3% 3%
Exp Net Income next year $ 150.00
First, back out the cost of equity for banks
PBV = (ROE - Cost of Equity)
Cost of equity = 9.00%
Next, estimate the price to book for Papillon Banks
Papillon's price to book = 2.00
Finally, estimate the book equity and market equity for Papillon
Book Equity $ 1,000.00
Market Equity $ 2,000.00

Problem 2
Current In year 5
Revenue $ 100.00 $ 1,000.00
After-tax Operating Income $ (20.00) $ 150.00
Book Debt $ 150.00 $ 400.00
Book Equity $ (30.00) $ 600.00
Cash $ 20.00 $ 200.00
Cost of capital 15% 9%

ROIC -20.00% 18.75%

Expected Growth in Revenue - Next 5 ye 58.49% 3%

EV/Sales in year 5 = 2.99

EV in year 5 $ 2,990.00
PV of EV today $ 1,486.56
+ Cash $ 20.00
- Debt $ 150.00
Value of Equity today = $ 1,356.56
Value per share = $ 6.78

I did not like the following solution, but I gave you full credit, if you stayed consistent
EV/Sales (based on current) = 2.78
EV = $ 277.91
+ Cash $ 20.00
- Debt $ 150.00
Value of equity $ 147.91
Per share $ 0.74

Problem 3
Private company valuation $ 200.00
Cost of equity = 18%
Growth rate forever = 3%
Tax rate 20%
Riskfree rate = 3%
Equity Risk Premium = 6%

First, back out the expected FCFF next year from value
Value = 200 = X/ (.18-.03)
Expected FCFF next year = $ 30.00
Next, adjust this FCFF for missed salaries
Missed Salaries $ 2.50
After-tax Missed Salaries $ 2.00
Adjusted FCFF $ 28.00
Third, compue the total beta from the cost of equity
Cost of equity = 18%
Total Beta = 2.50
Finally, adjust for correlation to get to a market beta
Correlation with the market = 0.3
Market beta = 0.75
Public cost of equity = 7.500%
Finally, get the corrected value
Corrected FCFF 28
Corrected Cost of capital 7.500%
Corrected Value = $ 622.22
d consistent
 Grading Template

1. Did not back out cost of equity for banking: -1 point

2. Did not incorporate effect of higher ROE: -1 pont
3. Did not go from PBV to equity value: -1 point
4. Math errors: -1/2 point each

1. Used wrong ROIC in regression: -1/2 to -1 point

2. Used wrong growth rate in regression: -1/2 point
3. Did not compute PV of terminal value: -1 point
4. Did not add "right" cash or subtract :"rihgt" debt: -1/2 point each
(You cannot subtract out the year 5 debt and add year 5 cash to your
Year 5 EV, because you will then have equity value in year 5, and you need
a cost of equity to discount it back. You are given only a cost of capital)

1. Did not back out FCFF next year: -1 point

2. Did not adjust for salary expense correctly: -1/2 to -1 point
3. Did not back out total beta: -1 point
4. Did not adjust to market beta: -1/2 to -1 point
5. Error in final valuation: -1/2 to -1 point
6. Math errors: -1/2 point