BUFN 750 Final Exam 2016 – Valuation of NovaTech
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Valuation for Corporate Finance
BUFN 750
Final Exam 2016 – Valuation of NovaTech
Total grade: 100 points
NovaTech (NT) is a start-up in nanotechnology based in Austin, Texas which has hired Goldman Sharks (GS) as its leading underwriter to conduct its Initial Public Offering (IPO) at the Nasdaq Stock Exchange. The IPO is scheduled for January 2017.
You are working for an investment bank that wants to know how much a share of NT is worth as of January 2016. The results of your analysis will be circulated among institutional investors in a bulletin with buy/sell recommendations for Nasdaq stocks, including NT’s IPO.
From the information provided by one of the venture capitalists with a stake in NT, you know that the proceeds from NT’s IPO will be used entirely to fund NT’s expenses in Research and Development (R&D) in the future. You also know that start-ups in nanotechnology pay no income tax in the state of
Texas.
The current financial statements of NT show that NT is currently unlevered. Given the current tax regime in Texas, the CEO of NT does not plan on issuing any debt in the foreseeable future.
The pro-forma statements of NT contain the following information:
The revenues of NT are expected to be USD 40 million in 2017.
The operating cost of NT is 10% of its revenues. Other administrative expenses are equal 5% of
NT’s revenues. Both proportions are expected to remain the same in the foreseeable future.
The capital expenditures of NT are 10% of its revenues. NT will reinvest the same fraction of its
revenues as capital expenditures in the subsequent years.
The depreciation of fixed assets from 2017 onwards amounts to 60% of NT’s capital
expenditures.
NT will spend USD 16 million in Research and Development (R&D) in 2017. R&D expenses
are expected to grow proportionately to sales.
NT requires no working capital to operate.
Three comparable firms have gone public in the Nasdaq Stock Exchange during the past five years. You have the following data on these firms:
|
AstraZen |
|
|
|
|
Equity Beta |
2.50 |
2.10 |
2.00 |
|
Market Leverage Ratio |
10% |
3% |
0% |
|
Market Capitalization (in USD millions) |
20 |
20 |
20 |
AstraZen and Phylos are based in California, whereas Protech is based in Texas. Start-ups in nanotechnology in California face a marginal income tax rate of 30%. The long term debt contracts of AstraZen and Phylos have investment grade credit ratings.
There is some disagreement among GS’s industry analysts about the expected growth rate of cash flows of NT. While some analysts say that NT’s revenues will grow at 2%, others say that NT’s revenues will grow by 15% annually.
Finally, the current US treasury 20-year bond rate is 4%. The current US treasury 1-year bond rate is 2%. Based on historical estimates, the market risk premium is estimated at 7%.
You should answer the following questions for the sake of writing a weekly report which will be circulated among the institutional investors of your investment bank.
1. Calculate the free cash flows and the appropriate discount rate for NT. What is the expected value of NT’s equity under the two possible growth forecasts for NT’s revenues? Carefully explain your analysis. [15 points]
2. NT has currently 9 million shares outstanding and is planning to issue another 1 million at the IPO. GS, NT’s underwriter, has set an offering price of USD 30 per share for NT's stock. Is this a positive NPV investment for the institutional clients of your investment bank? Carefully explain your answer. [15 points]
Assume now that institutional investors expect the State of Texas to eliminate the “no-tax” incentive for start-ups in the incoming months, before NT goes public.
3. Given a corporate tax rate of 30%, how would the change in the tax regime affect the free cash flows and the value of NT? Explain your answer in detail. [15 points]
Last, you are informed that the CEO of NT will raise debt before the IPO if the corporate tax rate is set to 30%. The CEO of NT will raise bank debt worth 10% of the market value of NT’s assets, in line with the financing policy of AstraZen. The CEO of NT will keep the leverage ratio at 10% in the long run. At such leverage ratio, the debt rate premium of NT will be 1%.
4. Indicate whether the following statement by a co-worker at GS is true or false, and explain why.
“The Free Cash Flows of NT will be substantially lower once NT becomes a financially levered firm. This is because there will be less left on the table for NT’s shareholders after servicing principal and interest payments each period.” [10 points]
5. Given a corporate tax rate of 30%, compute the market value of NT’s assets with financial leverage. Does financial leverage add value to NT? Carefully explain your answer. [20 points]
6. Given a corporate tax rate of 30% and having raised bank debt before the IPO, should the institutional clients of your investment bank buy NT stocks at USD 30 per share? What is the value of a share of NT? Carefully explain your answer taking into account the new tax regime, the financial leverage of NT and the NT’s analysts’ growth forecasts. [25 points]
2022-12-15