Page 1 ECOM118 (2024)
January Examination Period 2023-24
ECOM118 Practical Valuation Duration: 2 hours
Answer ALL questions
PLEASE ENSURE THAT YOUR WORKING IS CLEARLY SHOWN WITH ALL STEPS
OF YOUR CALCULATION INCLUDED IN YOUR ANSWER DOCUMENT, INCLUDING ANY
FORMULA USED.
Calculators are permitted in this examination. Please state on your answer book the name and type
of machine used.
Complete all rough workings in the answer book and cross through any work that is not to be
assessed.
Possession of unauthorised material at any time when under examination conditions is an
assessment offence and can lead to expulsion from QMUL. Check now to ensure you do not have
any notes, mobile phones, smartwatches or unauthorised electronic devices on your person. If you
do, raise your hand and give them to an invigilator immediately.
It is also an offence to have any writing of any kind on your person, including on your body. If you
are found to have hidden unauthorised material elsewhere, including toilets and cloakrooms it will
be treated as being found in your possession. Unauthorised material found on your mobile phone or
other electronic device will be considered the same as being in possession of paper notes. A mobile
phone that causes a disruption in the exam is also an assessment offence.
EXAM PAPERS MUST NOT BE REMOVED FROM THE EXAM ROOM
Examiner: Gonçalo Faria
© Queen Mary University of London, 2024
Page 2 ECOM118 (2024)
Question 1
A hedge fund manager is valuing a company that is expected to generate sales from year
1 onwards as given in Table 1. Year 1 is the company’s first year of activity.
Table 1
Year 1 Year 2 Year 3 Year 4 Year 5
€75,000 €79,000 €84,000 €82,000 €84,000
Expected EBIT margin (% sales) in year 1 is 6%. Additional assumptions are:
• EBIT margin (% sales): decreases 50 basis points (0.5%) per year until year 3,
including year 3, and increases 25 basis points (0.25%) per year in years 4 and 5
• Depreciation: 7% of sales, each year
• Recurrent Capex: 8% of sales for year 1, with this percentage decreasing 20 basis
points (0.20%) per year until year 4
• Change in working capital: 12% of yearly change of sales
• Tax rate: 20%
• Target capital structure: debt/(debt + equity) ratio of 60%
• Asset beta: 1.40
• Risk-free rate: 5%
• Equity risk premium: 6%
• Debt spread: 4%
• Expected net debt at the end of year 1: € 8,000
• Expected financial investments at the end of year 1: € 7,000
• Expected minority interests at the end of year 1: € 1,500
• Number of shares: 6,000
To answer the following questions, make plausible assumptions if necessary.
a. Compute the Free Cash Flows to the Firm (FCF) for the period from year 1 until
year 5, including year 5. Round computations to zero decimals. Explain your
answer.
[10 marks]
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Page 3 ECOM118 (2024)
b. Consider the following statement: “When computing the FCF, taxes are estimated in
a way that financing decisions are ignored”. Do you agree? Explain your answer.
[10 marks]
c. Given the target capital structure and the set of assumptions reported below Table
1, what is the discount rate to be used in this valuation exercise? Explain your
answer and round computations to two decimals.
[10 marks]
d. The company is expected to operate beyond year 5 and the expected nominal
growth rate of FCF in perpetuity is 2.00%. What is the expected value of the
company at the end of year 1? Explain your answer and round computations to zero
decimals.
[10 marks]
e. The company is trading at €6.22 per share. What is the investment recommendation
considering the expected equity value at end of year 1? Explain your answer.
[10 marks]
Question 2
An investor is valuing Company ECLAT which has the following expected key financial
measures for year-end 2024 (Table 2):
Table 2
Equity value €22,000
Level of cash €7,000
Level of interest-bearing debt €2,000
Minority interest €1,500
Financial Investments €6,000
Number of equity shares 2,500
2024 Expected EBITDA €2,600
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Page 4 ECOM118 (2024)
Additionally, the investor has the following information about a set of comparable listed
companies that are similar both in terms of leverage and in terms of other fundamentals
(Table 3):
Table 3
Company Enterprise value EBITDA 2024
B €36,000 €5,000
C €20,000 €3,000
D €59,000 €7,900
For your answers, round computations to one decimal place (e.g., present 1.56 as 1.6).
a. What is the 2024 enterprise value/EBITDA (EV/EBITDA) multiple of company
ECLAT implied in the investor’s expectations? Explain your answer.
[10 marks]
b. Consider only the information on the 2024 EV/EBITDA multiples of the set of
comparable companies. What is the conclusion about the relative valuation of
company ECLAT? Explain your answer.
[10 marks]
c. When using a certain multiple in the context of a valuation exercise, it is irrelevant to
consider the set of fundamental variables that command that multiple. This is due to
the fact that multiples are a relative, and not absolute, valuation exercise. Do you
agree? Explain your answer.
[5 marks]
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Page 5 ECOM118 (2024)
Question 3
The company GAMMA is evaluating the possibility of building a new production line (‘the
project’). It implies an immediate investment cost (year zero) of €540 million. The discounted
value (year zero) of expected cash flows is €480 million. However, GAMMA has the option
to further invest €210 million within 1 year, which will enable it to duplicate the dimension of
production section, increasing by 55% the discounted value of cash flows.
Assume the following:
• Risk free interest rate: 4% per year.
• The project gross value follows a multiplicative binomial process.
• Method for the computation of remaining relevant inputs: compound annual
growth. The market value of the shadow asset is given by S. Currently S = 20
and the estimation is that within 1 year S = 27 and S = 14 for the scenarios of
favourable and unfavourable market evolution, respectively.
In your answers to the next questions, make plausible assumptions if necessary.
a. What is the real option in this project? Explain your answer.
[2.5 marks]
b. What is the value of the investment opportunity that the project represents? Explain
your answer.
[10 marks]
c. What should be the investment decision regarding this project? Explain your answer.
[2.5 marks]
d. Consider the following statement: “The flexibility that a management team most of
the time has in the implementation of an investment project represents value by itself.
However, this value may not be fully captured in a standard Discounted Cash Flow
model. Real options techniques may provide, at this level, an important contribution
for the valuation exercise”. Do you agree with this statement? Explain your answer.
[10 marks]
End of Paper
End of Examination/ Gonçalo Faria
© Queen Mary University of London, 2024
