01a - Sample Midterm

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University of Pennsylvania *

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Jan 9, 2024

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First four digits of PennID ______ 1 Sample Midterm Corporate Valuation Professor David Wessels Penn ID : _____________________ (do NOT write your name) You have one hour and 15 minutes to complete this exam. This is a closed book exam – to be done on your own. You can use a calculator, but not a computer. You can have a one sided sheet of 8x11 notes. I expect you to follow Penn’s honor code during this exam. There are four questions, each with subparts. The total exam is worth 60 points. Each page is worth 15 points. You can use the back of the previous page for additional room on any given question. The exam has 6 pages (including cover). Count them. Make sure to attempt EVERY question; do NOT get hung up on any one question. Credit will be given for partial work. If you do not have an answer available from a previous question/subpart, make one up! Remember, the less work you show, the more risk you take of losing points. You must write clearly, so SLOW down. If illegible or poorly organized, you will be docked points at TA discretion! Good luck!
First four digits of PennID ______ 2 Question 1: Value Driver Models You are valuing Philadelphia based CableCo. The company is expected to generate $600 in revenue next year. The company is growing consistently at 4% per year, operating margins are stable at 15%, and after tax returns on capital equal 8%. Assume the tax rate is 20% and the weighted average cost of capital is 12%. a. Use the key value driver equation to value CableCo. b. Use the Stern Stewart (capital based) value driver equation to value CableCo. c. If the consensus revenue growth forecast rises unexpectedly, would the company’s stock price rise or fall? Why?
First four digits of PennID ______ 3 Question 2: Operating Taxes You are investigating Fahrenheit, a manufacturing of high caffeine fruit based drinks. The company has been growing steadily, and profitably, but did writeoff its only acquisition in Year 2. The writeoff was not tax deductible. The income statement and its accompanying notes are as follows: a. What is the marginal tax rate in Year 2 and Year 3? b. What is the effective tax rate in Year 2 and Year 3? c. What is the operating tax rate in Year 2 and Year 3? d. Why is 5% (which is 21% 16%), not an appropriate operating tax rate for Year 2? Income Statement Note 7 Tax Reconciliation Table $ millions Year 1 Year 2 Year 3 Year 1 Year 2 Year 3 Revenue 1,000.0 1,100.0 1,200.0 Statutory tax rate 21.0% 21.0% 21.0% Cost (900.0) (980.0) (1,070.0) Manufacturing credit 3.3% 16.0% 3.6% EBITA 100.0 120.0 130.0 Goodwill writeoff 0.0% 67.2% 0.0% Effective rate 17.7% 72.2% 17.4% Interest expense (10.0) (15.0) (20.0) Goodwill writeoff 0.0 (80.0) 0.0 Pre tax profit 90.0 25.0 110.0 Taxes (15.9) (18.1) (19.1) Net income 74.1 7.0 90.9
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First four digits of PennID ______ 4 Question 3: Economic Profit & the Cost of Capital You are examining Johnson Controls, a maker of industrial equipment. Next year, the company expects to generate $160 million of pre tax operating profit on $720 million in revenue. Revenue, profit, and cash flows have all been growing steadily at 5%. To support operations, the company deployed $600 million in capital, financed by $150 million in debt and $450 million in equity. The risk free rate is 5%, the company’s cost of debt is 6%, the company’s cost of equity is 14%, and the tax rate is 25%. The company currently has 60 million shares outstanding and trades at $15 per share. a. What is the company’s weighted average cost of capital? b. What is the company’s expected economic profit?
First four digits of PennID ______ 5 Question 4: Enterprise Valuation You have just downloaded an analyst report on AirCo INC. In the report provided on the final page of this exam the research analyst provides a three year forecast of the income statement. You estimate invested capital turns at 4.0x, continuing value growth at 3%, and the cost of capital at 10%. a. Please create a two year explicit forecast of free cash flow, using the traditional form of free cash flow. Do not use the abridged version. b. Please estimate the enterprise value of AirCo using a two year explicit forecast and a continuing value based on the key value driver formula. c. If the company has $600 million in debt outstanding and 120 million shares, what is the value per share for AirCo?
First four digits of PennID ______ 6 Forecast $ millions 2022 2023F 2024F 2025F Revenues 750.0 800.0 1,000.0 1,100.0 Cost of sales (580.0) (600.0) (650.0) (700.0) Depreciation (70.0) (80.0) (115.0) (130.0) Operating profit 100.0 120.0 235.0 270.0 Interest (34.0) (40.0) (45.0) (50.0) Earnings before taxes 66.0 80.0 190.0 220.0 Income taxes (16.5) (20.0) (47.5) (55.0) Net income 49.5 60.0 142.5 165.0 Note: Assume today is the last day of FY 2022. Income Statement AirCo INC
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