Valuation Finance Assignment -
Problems on Loose Ends in Valuation, Valuing Private Firms and Firms in Restructurings, and Relative Valuation.
Problem 1: VALUING A LEVERED FIRM WITH STRUCTURAL CASH RESERVES
Suppose you are an equity analyst performing a valuation of Alcoa, and you collected to following inputs:
- The regression beta of the firm, estimated over the past 5 years, equals 0.90. During this period, the firm had an average total (market) debt/equity ratio of 20%, and an average cash balance of 15%.
- The firm's current market capitalization equals $1.6 billion. The current market value of its debt equals $800 million. The firm furthermore has $500 million of excess cash and marketable securities on its balance sheet.
- Alcoa's current earnings before interest and taxes equal $430 million. This amount includes interest income on the current cash balance of $30 million. The firm's marginal corporate tax rate equals 40%.
- The firm is in stable growth, and its earnings from operations are expected to grow at a rate of 3% per year. The net capital expenditures next year are expected to be $100 million.
The risk free rate equals 6%, the market risk premium is 5% and the firm has a cost of debt of 7%. Based on this information, determine the value of the firm and the equity of Alcoa. Show all your calculations.
Problem 2: DETERMINING THE VALUE PER SHARE OF GENIUS MEDIA
Suppose you have been asked to value Genius Media, a high technology growth firm, and you have been able to estimate the expected revenues, EBIT and reinvestment (which includes Net Capital Expenditures and Changes in Operating Net Working Capital) for the next three years (in $ millions):
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(x$1 min.)
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Year 1
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Year 2
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Year 3
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Revenues
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600
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900
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1,000
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EBIT
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-100
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100
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150
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Reinvestment
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100
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150
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50
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With this information, please answer the following questions.
(i) Assuming that Genius Media currently has a NOL (Net Operating Loss) carry forward of $50 million and a marginal tax rate of 40%, estimate the Free Cash Flows to the firm for the next three years. Motivate your approach and show your calculations.
(ii) Assuming that the firm is all-equity financed and is expected to have a cost of capital of 15% in year 1, 12% in year 2 and 10% thereafter, determine the value of the expected cash flows for the next three years. Show your calculations.
(iii) The firm is expected to be in stable growth after year 3, growing at 3% per year indefinitely. Assuming that the firm's NOPAT in year 4 equals $92.7 million, the book value of invested capital in the firm currently equals $472.5 million, and that the Return on Invested Capital generated by the firm will be sustainable indefinitely after year 3, what is the terminal value of the firm at the end of year 3? Motivate your approach and show your calculations.
(iv) Now suppose that you learned that Genius Media has a cash balance of $80 million and also owns 10% of a software entertainment firm. This 10% holding isrecorded at its book value of $40 million, and the average price to book ratio ofsoftware entertainment firms equals 2.5. In addition, you found out that a competitor has sued Genius Media for patent infringement, and have estimated that there is a 25% probability that Genius Media will lose the lawsuit, in which case it will have to pay $100 million in damages. What is the value of the firm's equity based in this additional information? Motivate your answer and show your calculations.
Problem 3: DEALING WITH EXECUTIVE STOCK OPTIONS
Suppose you are valuing a technology company, and have determined an enterprise value of $800 million. The firm has no excess cash and no debt, but it has issued a considerable amount of employee stock options (10 million in total). Based on an option pricing approach, you have valued the options at $6.67 per option. If the company has 40 million of shares outstanding, what is the firm's equity value and the value per share? And how would your answer change using the exercise value (or Treasury stock) approach? You can assume an average strike price of $15.
Problem 4: VALUING CONTROL IN A PUBLIC OFFERING OF A PRIVATE FIRM
Suppose you have been approached for valuation advice by the owner of DosTacos, a private restaurant chain that is planning to go public in the near future. You are provided with the following information for the firm:
- DosTacos is expected to generate $5 million in after-tax operating income on revenues of $100 million next year. The book value of capital invested in the restaurant chain equals $50 million and the after-tax operating income for DosTacos is expected to grow at 4% per year inperpetuity.
- There are significant inefficiencies in the way the restaurants are run, which are attributable to the owner's management style. If these inefficiencies were to be eliminated, DosTacos could generate $6.5 million in after-tax operating income next year on the same revenues, although the expected growth is unlikely to be affected.
- The unlevered beta of publicly traded restaurants equals 1.25. The average correlation of the sector with the market is 0.40. The yield on T-bonds equals 5% and the market risk premium is 4%.
- The restaurant chain is all-equity financed.
With this information please answer the following two questions
(i) Estimate the value of DosTacos ofthe firm with existing management for a public offering. Motivate your approach and show all your calculations.
(ii) Assume that the owner is planning to issue 2 million voting shares and 3 million non-voting shares in the company. Estimate the value of control in the firm, and also determine the value per share for each class, assuming that there is a 20% probability that the management of DosTacos will change. Show your calculations.
Problem 5: VALUING BANKS USING RELATIVE VALUATION
Suppose you are an analyst working for a hedge fund and you are assessing the pricing of two regional banks operating in the south east region of the US. You have been presented with the following information on a per share basis:
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Sun Trust Bank
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South East Bank
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Market value of equity
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150.00
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100.00
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Book value of equity
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90.00
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80.00
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Expected Net Income next year
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18.00
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12.00
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You have furthermore determined that both banks are in stable growth, growing at 3% per year, and have the same cost of equity. If you believe that SunTrust Bank is fairly priced by the market, make your best assessment of South East Bank. Motivate your approach and show your calculations.