FIN 550 Midterm Solutions_Spring 2020

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Feb 20, 2024

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FIN 550 )\(_ Q l) \Cl? So LV71 <l ~s ~ idterm Spring 2020 [ , ~ ~ E: : ,,0~ c -ri., j D "~ , o r-J S oF 11-t £"" €"X A- v:: [Total of 25 points (parts a -d)]: Given the assumptions below, complete the pro-forma financial statements. Assumptions Units Sold Sale price (unit price) Cost of Goods Sold Variable costs (per unit sold) SG&A Fixed cost Variable costs{% of revenue) 2021 2,500 $ 90.00 $ 50.00 $ 12,000 10% M uc.μ s 'tll P u-...-r-- \J ~ s '~μ o c &, v2..ou P A ss \<'.~, ,, H .tt ~ J.. Depreciation (% of lagged fixed assets) Interest Expense(% of lagged NP and LTD) Relevant Tax Rate 10% 10% 20% Days Sales in Inventory Days Sales in Receivables Days Payables Outstanding Capital Structure Decisions Planned Notes Payable (Year End) Dividend Payout Ratio a) (4 points] Income Statement Revenue Cost of Sales Gross Profits Operating Expenses Depreciation G&A Total Opex Interest Expense Earnings before Tax Tax Expense Net Income ,, Actual 2018 80,000 (48,000) 32,000 (2,500) (20,400) (22,900) 45 40 30 ??? 500/o 2019 132,000 (72,000) 60,000 (4,000) (25,840) (29,840) Pro jected 2 020 2021 170,000 1'2.S 1 000 (93,500) ( 1 25' 1 000) 76,500 100 1000 (5,739) ("1- , '2 ~4) (29,700) ('!> ~ Soo) (35,439) (4\ ) 1-"!>4; ( 1, soo)I .__ _,_( 2...;_, 5_00..,;.J,.) I _...:..,_ ( 3,;.._53--=9):..& .... I (...:..,_7..---1,.) _~ ~ .:__ 3...L...1 ) I 1,600 .__ I _ 2_ 1, _ 66 _0 _._ I _ 3_7_ , s2_2 __._ l _s_s..__ , -; _ ,- ___ 3 __. I (1,520) L- 1 _____:,_ ( 5 ..... :... , 5_ 32 ..... :... ) IL--_.:.. (7 .... :... , 5_04 _:..j ) l .__;_ (_1 I_, I _ I 5 _)__. I 6,080 22,128 30,017 441456

FIN 550 b) [6 Points] Balance Sheet Assets Current Assets Excess Cash Required Cash lm,entory Accounts Receivable Total Current Assets Equipment, net Total Assets Liabilities & Owners' Equity Current Liabilities Notes Payable Accounts Payable Total Current Liabilities Long Term Debt Total Liabilities Common Stock Midterm Actual 2018 9,863 6,575 6,575 23,014 40,000 63,014 5,000 3,945 8,945 20,000 28,945 Par and APIC 37,988 Retained Earnings (3,920} Total Stockholders' Equity 34,068 2019 - 14,795 10,849 10,849 36,493 57,391 93,884 15,393 5,918 21,311 20,000 41,311 38,791 13,782 52,573 Spring 2020 Projected 2020 2021 - G~.1~5 19,212 25,685 12,808 15 , 41 I 16,301 24 ,, 59 48,322 /3 u~~4'3 72,340 93,750 120,662 225 (p'3<3 6,928 - 7,685 fD 1 21'4 14,613 I 0 1 '2. -+ + 20,000 90,000 34,613 ID0, 21"4 48,253 65,400 37,796 Coo , 02.s 86,049 l 2S i425 Total Liabilities & Owners' Equity __,6 , ..... , ~ , ..... ' 0_1 _,,. 4 ..... ,. l _ 9 ___ 3, _ 884 ___, l ._,,___ 12 _0 ..;,_ , 6_6_2 ........ I ..... ,2,., .... 2...:.,.. 5 ..,,., 1 (o .... ,,.'3,..,,.;,,9, ..... jl ~£2. 1 -:; 31- , ~0+ C1-.c;')(44,4S8J-= (oo p 2s rNV-= (4 .S /i ~·)( 12 s, ooo) A-/ (2. ~ (. 4o/3w S) ( 22'!.,oot,) ft / p ; ( 3 0 / 3 1,o c;) ( I Z 5, O 0 0 J

FIN 550 Midterm Spring 2020 c) (13 points] For the firm above, assume that the WACC = 10% and the relevant tax rate= 20%. Also , a ss um e that the terminal PE Ratio= (Price per Share)/ (Net Income per Share)= 14.50. Calculate the value of the firm (the present value of the Enterprise Value). To ease your computational burden. I have calculated the FCFs for 2019 and 2020 as negative 4,770 and positive 7.838. respectively. Use the mid-year convention when discounting future cash flows, and assume that the valuation date is the beginning of 2019. E ~ , -r;_, ( I --t) -:: 4lo , lD 13 C.Af ~ -: ~ Nf P€. -t D~ -+ D E'PR '1,l ~ 1-, '2.~ 4 - c.. M'Q'1, -; ( 1..~ )~44) - ~N() WC 11 ~ C 14 1 't)4";") f c.. ~'2\ \D l ~(oO f: \J o= P \J PP 4 P\J.rv - 4 1~ --:J,O +,<o'3'o + 10,~{oO P\J Dr:;, :: ~ + ' . ~ \ , ,, ,. . s ,.., \,lo• \ .10 •""" d) [2 points] What is the implied current EBITDA multiple? - -

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FIN 550 Midterm Spr i ng 2020 Weighted Average Cost of Capital (WACC) [15 points]: An acquiring firm with a market capitalization (MVE) of $2 ,210 seeks to purchase a target firm with an MVE of $3,450. Estimate the combined firm's WACC given the following information. When aggregating betas, use the equally weighted average. Tar et Firm's Com anies Book Market Comps Pa1io Value Value Tax Debt Equity Rate Firm A 1.696 2,300 2,588 27% Firm B 1.828 1,450 1,377 30% Fl rm C 1.396 680 1,332 25% Risk Free Rate 3.00% Expected Mkt Return 8.50% Most Recent Debt Offering Default Spread 5.00% Combined Firm's Target Ratios Equity/ Value 0.70 Debt /Value 0.30 Firm's Marginal Tax Rate 24% Y o"™ E:12. v~ s, o.J μ_ A- c ~il'I\ I\ '5 Pi ~ t \J ~ t .J (. A-e.o\J~) , I,-.) T\--( A-1r c..A 1.C ( ~ ~ ltTt-'\ ~ Ac Comparable Companies Firm D Firm E Firm F anies ~ l _s A-e.E°' J,,0~T Market Tax 11. Value Value Rate T'" 1€ M}-e~~ ,, Debt Equity 1.737 9,312 5,677 30% NOT k~u...mi~-, 1.894 2,994 1,603 24% .... ,~ LU C ~ 1.557 1,798 1,167 26% * \J F;2.'y S IM l I... AfL 1'0 !: ~ .. e,~ -r. E'X ~ fJ (... ~ A+,.) D G, 2.-i.l u ~ A- ~CS t~ N~ ~ 1.. ,-_

FIN 550 Midterm Spring 2020 (8 points]: CLEARLY CHOOSE AND CIRCLE EITHER (AJ OR (BJ IN THE SPACE PROVIDED- I WILL NOT GRADE BOTH .. . A) Briefly explain why valuation professionals calculate the implied terminal growth rate for the DCF -terminal multiple method and the implied terminal multiple for the DCF - terminal growth method. What is the primary reason that they do this? B) Briefly describe three fundamentally different problems / concerns when valuing a firm using the precedent transactions method. P.') !Mp\ \~~ 'f'<\ ,> ~ p\t o. . f\Ji. ~f"b~ n>..Te o--r<., ~~ ~~. 't r r:~-So l"l <L~~(\.ess '' ~ \\"~ ~s . 1:~ 'oo~~ • M~~~~~ 0 ~ ~ 'i, t,~°tl"j -\.~ ~f'VV' 1N'--~ , ,¢t.. b. rt- ~rt d tt 4' r\ s:, tolQ. , .;.,- ,d pr i.) ~r \J ~~ } ) +he~ 't"~ \Mr l1 i- J ~la.. "t~ ~ v·n~t.J I el 64 ' 1 c.,\ o~ ,, ~ ~ ~tS 1.H -l\'1'.A ~to... ., st),+k ,,;... . LeJ. Wlvl-hf~ ~h,.,uld.. ~ ''C.lo!if ,. h ~ ~ \J \+,flt 1.Jf .,C~ ) 1 (0, J"i ,i +->.!. IM {' It ~ J j ~t· l, .... t h 'a._ t, s h<.1.U \,4 , ' <!. L:. -... ' . +o {~ 5 '1) ,.A ::h ,,...,_ i; (A -st...l ' I!;,) \} C().,r-. ha. (k \ •~~~~ +o t~ pH e~d.~t\ "t 1'f 'o...l\~~ ,: +({~~ ,. (JM..~ 11 (0 0~ t:_l« 1 . '( UI A ~t {~ po--r · h(_~\ .,. t\rW t ~ ~ ·l--~ v~.l 1J ll\..t,~~ ( ~r e.v «..r ~) -z.\ t;) oe~ ~u + tJ.A ~ jQcl d- ~~ _c ~ C~('>+-ur-1½ +kt uV',\vC c \ 1'ft . r.o. ,~ r-is+, ,~ )S~',-¼.~ 1 ~ b - \. t3\ .CSSf''!. , c__'"'""' ()e-t\~\rf;. l d. 1-i ')~ J..1Ji:,.,11.-to.ie~ 1 e.i c , ~ ~ ~~""- f. /M . ~) ~ 4j. h~u..,~~ t> ~ ~ ' 't -0r1 ~I p r~~IO I" «\ '' Ct'v \ be: J .. ~{{ 1 ,~ 4, f '?~ ("..e.h"l'"t +-, ~o ~ + 1-1 P\c.c'(_ t(, l.6~ \r.l l~~ 0,. p~ r.1 t ui,, , ·n• t«tfJJ ~ ~t~ C~Y'\~t ~ ~~ eo.,~\"\ ,4: t, w_s [6 points]: CLEA1lLY CHOo'sE AND CIRCLE EITHER (AJ OR (BJ IN THE SPACE PROVIDED- I WILL NOT GRADE BOTH ... A) Assume that you do not trust the current price of a debt issuance (bond). This can happen if the debt issuances are thinly traded (not traded frequently). Briefly explain two alternative approaches to determine the cost of debt capital. B) Briefly explain two fundamentally different reasons why venture capitalists rarely use CAPM when valuing a start- up company. In other words, why is CAPM a likely inappropriate risk-return model for start-up companies? A) Yr M t1o -t~" '+ wiir k. ., 1; l~ A loo lt.. ~+ b (,)"f\ ci ~ ,-, ~ .s o..AJ ~ f'\ J ~ olt~~ L °'" ~pr~ _ J. • r~. 'r. 'ff+ D«~-o..u. l-t $p~.(. . 2.)"t~ ~~ ~(~ t:ioP" M1 ho..~ . o.. ~<;-,,ti. ro..,+"t"") l w,e. Co.."' pv ~r~ "'- ''i.~ l\il~4ic. ~~ if'~'ti~, · bj ei<-..M1t1 t i\' r ~\~!Jlfl.+ ('f,o..ttu.C l ~t'~ l't'nA /,;t-!f't \C/E 1 ~Ji'S~/ 'TA )" f .:t- c. .) ~f'\6. ~• c rww ~~ . ~, ~ ~ C- -OM~ r- 1' \ ~ c{ki r 't' t ~~ ~ ,- ~ ~vt. k> o ~ ~+1 "' 5' ,. ~et\ , Wt t 11 ..,.._ ~r-J ~ - ~ ti.H '1'. P "'"r~~ "4? ~ut'\ _ ! f'"t: .... ~ 1 ~ 1 t1) '}Gt ~ ~~ t"'t ~q,->rc•\ ._{ , 1) Tt ~ C..O M~" J i/"~CC/'t'tlJ I SSutJ 'f. lN\ d c,if' tl~½t I l,..,e. Cl1-\-1 l.\\o~ Q--1; 4~tr ,;t, 6) \) tA4(j';'lc \l'\ '~f ~t~ f' '" · ~) pi'c,((y ~\ d,V{r ,,{',,~J I "l )t-1\of~ ~\} ( ~ \~ q{ up (l t uTt ·1 ,·, +j rl · c- .. l(J ~$ (P~ ~(1~ 1 • :t o~~s •• •

FIN 550 Midterm Spring 2020 Finite Project [18 points]: A firm has three years remaining on an existing finite project. Management is evaluating an Enhancement Opportunity (new project) that lowers SG&A expenses and reduces the amount of Requ ired Cash necessary to complete this existing project. This Enhancement Opportunity will not materially affect COGS or any other net operating work capital accounts such as A/R, Inventory and A/P. Projected Capital Expenditures (Capex) will be $18 million in 2019, $6 million in 2020, and $4 million in 2021. Assume t hat all Capex will be spent at the beginning of each year (for instance, the $18 million 2019 Capex will be spent at time = O J. Assume that you recognize operating cash flows (ie. Income statement items} in the middle of the year. Assume that the Net PP&E can be sold for $11 million at the end of 2021, and that you "recoup" (free up) the Required Cash two months after the sale of the equipment. You estimate the WACC of this Enhancement Opportunity at 9.0% , and the relevant incremental tax rate is 21.0%. calculate the NPV of this project. (a mo unts in $m illio ns ) PlrOJECTED SGAA EXPENSE / Actual (last year) Projections ~ ~ ev' ~A--L ~,+MPL.E'S Do not invest In the Enhancement Opportuni ty (base case) I nv est in th e Enhancement Opportuni ty (new project) I 2018 30.80 30 .80 2019 61 . 60 56.00 2020 2021 67 .58 70 .95 57.35 60.06 T. t-,..) p ra.A-'-~ M~ M-. Wt' WM--~~ THeou<:,'-l PlfO.IECTED REQUIRED CASH ~ .,5 Do not Invest In the Enhancement Opportunity (base case) 25.20 49.00 52 .70 56 .10 ~ !Zi(A+'\ ~ Lt \c,IS' . I Invest In the Enhancement Opportuni ty (new project) I 25.20 44 .80 46.50 47.85 Dua., t-,l G,,-1 ou 2. '1 (2.~ I E;'W ADOITIONA~ DEPREOATIO ~ IF TAKE PROJECT I 9.00 7.00 5.00 s € ~,5 f ~0 N, 11 'l", cyJ - c. ~i - % ~ ft • t> ;;ft2')(1 " -le )-+ l>E f' 2. • tM"")( - ~ ec. t ~ ~ ~ - ¥7') 2.0 1') 20 2. a i~t\ . -- s~ ~A i_. 1;::~- ~rl t. ~ti S". (po I O, 21 I o, 9'3 • Af=- T0L-TJV(. f2.0C£E~S - 4.424 8.oe1- ~ M\J - C tA\J- ~ \J JC-e.\ -= ~ ~-ra't 'T *Y... ,. C, /j Re.. C '' v5 ~ 11 <:F c~srt) 3 ~s~ c~~~ l ~MA.') N ~ Pe,b'J'E c::t D \ ff tft fC t-,.ll-t b EP l2. T/'r"/- s~ 1 rt.I) -=- t;l!Pe C 1=\ ,, • • ~ ~ - , 1 ~ T ~ c.)rQ..€FUL 1""'0 2.-; -80 11 , &c 4,2.0 .,;.._.,--- 2.. 0 0 ~ I .4 ":t II ,se;z. Tl-{~ 11 \.-UlW MIJC.~ 10 .~1 .+ ~ ~ 1,5 P 'I = -1 8 + T. o~7( - I .o~, 1 1. sc;2. 1 ,, 0 '1 1 " 5 rr - :: r $4,i s ff,.1 \\1 0A 3.40 r • 35" z. os - I .os II .+01 I\ - (11 - -=r)(. 21 ') .: fO.lb ----- [ B\J : A i. 1.. ~ -A-LI- (:) re:t e. 1 • 12 ~c.ouP / "f e. ~= vr ~ s (o • 1 o - 4- 1- . e,s = s . '"s - L~ 1:F W~ TJ4i\c.e- t--..J 1DW P 1to:r e c: .T •

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FIN 550 Midterm Spring 2020 Enterprise Value of a Firm Part A (16 points]: You are comfortable with the following projections. You estimate that the WACC is 14. 5%. The projected terminal growth rate {after 2021) is 4.1%. Assume that all cash flows occur in the middle of the year. The firm's marginal tax rate is 26%. What is the value of the firm? Actual Projected Amounts in $millions 2018 2019 2020 2021 Revenue 100. 00 200.00 245.00 260.00 Cost of Sales !45.00} !90.00} !110. 25} (117.00} Gr oss Pr ofits 55.00 I 110.00 134.75 143.00 Operating Expenses Depreciation I (12.00) (15.00) (18.00) (20.77) G&A (10. 00} (20.00} (24.50) (26.001 Total Opex (22.00) (35.00) (42.50) (46.77) Interest Expense I (6.00) (7.00) (7 .00) (8 .00) Earnings before Tax I 27.00 68.00 85.25 88.23 I I Tax Expense I (6.75) (17.00) (21.31) (22.06) Net Income I 20.25 51.00 63.94 66.17 NetPP&E I 42.00 48.00 52.00 51.00 NOWC I 10. 00 20.00 24.00 23.00 Part B (2 Points]: What is the implied terminal EBITDA multiple? ~ V rze.'( s IM I L. A1'2. iv Gi 12.uuP As, ia,, , .JM~.,- 1.. (C .... rw\;JT\-l V',tjP~I...) ''S~~'f 'i.'i~ '"' ) ~ P\J -r,1 T , 1 = ":tl.oOi(o (\ iy c: .\'s ~°"I.P-y~w ".sn ; ~' ' fo \ • ...;J +r,m ,~- '41" 1 , 14 '5 "' , 04 \ ) ~ o.. cc.o ur1 - '\'U 1 l C..OY' "' "11 on ,

FIN 550 Midterm Spring 2020 Cost of Hybrid Security (10 points]: You want to estimate the cost of a firm's hybrid security. The securi ty was issued three years ago a~ The price is currently $53/security. It pays a semiannual dividend of $3.00/security. The company has the one-time option to buy back the security for $55/security in 5 years, which would cause the securities to expire. Your research indicates that the company will exercise this buy-back option with a probability of 40%. What is the annualized cost of this firm's hybrid security capital? 4&.i\Jf.)~""Ni~" Wfr ' '){_ \'-' \S o t-J 'S t-1\A~ H~'E · B ~ t..\ G't-l ALL" t..l ~ I "'-1 ~ F¢(?.. \iOM~ T u~, - tJ E'f b 1t> i. ~6-A-1t. "'nt ii4 C11~ t>ow t-J l:~t> ~ 1 M-~ I...~ ~.AC.IL U f) ~ PMt"t~ 4-ND r!v'~ P\/-= - 5 3 N ~ \o PMi ~ '3 F" -: ~t'j ~~ ? ~ S.~4 '1- 11 /~ 'I! t n, co 'l s ~!~ r------ Time Value of Money: PV = FV / (1 + r)t CAPM : E[Rd = r 1 + lh(E[RM] - rr) I I Lu t.) \t: S I_\ •:.C ~ f 1 /f,,; p I?. ~1= e t Q. Et:> ,S,U(.,$., Ip ~ ( A..., .... u,.,_ b1ii1~f;NC )/ Ccv fl- ruM l"!i ~ .. ) -= (?.')($ :: 11 ,; 2.1 % is i -~ C:$ ,-; • 4( I\ · ~~Si') +. ~ ( I 1. i 1.\ /") =§ B BL u "' [ 1 + (1- Tc) x (D IE) ) Pv CF 1 perpetuity = - r-g r, _ Div/ P - Price Net Capital Spending= Ending net fixed assets - beginning net fixed assets+ depreciation Enterpr is e Value = MVE + BVD - Excess Cash Inventory Turnover = COGS I Inventory Re ce ivables Turnover = S ales/ Accounts Receivable Payables Turnover = C OGS/ Ac c ount s Payable EBITDA Multiplet= Enterprise Valuet / EBITDAt-i Days Inventory (annual)= 365 / Inventory Turnover Days Receivables (annual) = 365 / Receivables Turnover Days Payables (annual) = 365 / Payables Turnover The ~1 (s lope)= Covariance(R,,RM)/Variance (RM) = Correlation(R 1, RM)o 1 / OM