ECOM105 Valuation 2020
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Main Examination Period 2020 – January - Semester A
ECOM105 Valuation
Question 1
An investor is studying the company FLASH in order to make an investment decision. The investor's estimates of Free Cash Flows to Firm (FCF), levels of debt and net Financial Expenses (FE) of the company are presented in the following Table 1.
Table 1
|
Year 2019 |
Year 2020 |
Year 2021 |
Year 2022 |
Year 2023 |
Year 2024 |
FCF |
- |
€7000 |
€8250 |
€9100 |
€10130 |
€12200 |
Level of debt |
€700 |
€920 |
€1100 |
€1250 |
€1500 |
€1620 |
FE |
- |
€40 |
€43 |
€50 |
€60 |
€67 |
Additionally, the investor has made the following assumptions: (i) risk-free interest rate: 2.5%; (ii) target capital structure: debt/(debt + equity) ratio of 55%; (iii) equity risk premium: 6%; (iv) asset beta: 1.25; and (v) tax rate: 20%. The number of shares of the company is 9000 and the current market price of FLASH is €8.45 per share.
To answer the following questions make plausible assumptions if necessary.
a) Compute the yearly Equity Free Cash Flows (EFCF) for the period from 2020 until
2024. Explain your answer.
[15 marks]
b) Assume the expected nominal growth rate of the EFCF in perpetuity is 2%. Calculate the expected equity value of FLASH at year-end 2020. Explain your answer.
[15 marks]
c) Considering the current market price of the company, what would be the investment decision of the investor? Explain your answer.
[5 marks]
Question 2
The company DMI is evaluating the possibility of building a warehouse (‘the project’). It implies an immediate investment cost (year zero) of €300 million. The discounted value (year zero) of expected cash flows is €250 million. However, DMI has the option to further invest €125 million within 1 year, which will enable it to triplicate the production capacity, increasing by 65% the discounted value of cash flows.
In your answers to the following questions, round computations to two decimal places (e.g., 1.555 is rounded to 1.56) and assume the following:
Risk free interest rate: 3% 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 = 18 and the estimation is that within 1 year S = 27 and S = 11 for the scenarios of favourable and unfavourable market evolution, respectively.
To answer the following questions make plausible assumptions if necessary.
a) What is the real option in this project? Explain your answer.
[2.5 marks]
b) Compute the project’s simple Net Present Value (or “static NPV”). Explain your answer.
[2.5 marks]
c) What is the value of the investment opportunity (expanded NPV) that the project represents? Explain your answer.
[15 marks]
d) What is the value of the real option contained in the project? Explain your answer.
[2.5 marks]
e) What should be the investment decision regarding this project? Explain your answer.
[2.5 marks]
Question 3
An asset manager is valuing the Company A which has the following expected key financial measures for year-end 2020 (Table 2):
Table 2
Enterprise value |
€74000 |
Level of cash |
€5350 |
Level of interest bearing debt |
€9800 |
Minority interest |
€850 |
Financial Investments |
€1750 |
Number of equity shares |
2500 |
2020 Earnings Per Share (EPS) |
€2.95 |
Additionally, the asset manager has the following information about a set of comparable listed companies with similar leverage and other relevant fundamentals (Table 3):
Table 3
Company |
current market price per share (€) |
EPS 2020 (€) |
B |
14.0 |
2.5 |
C |
8.0 |
1.4 |
D |
7.0 |
1,2 |
For your answers, round computations to one decimal place (e.g. present 1.56 as 1.6).
a) What is the 2020 price/earnings multiple of company A implied in the asset manager’s expectations? Explain your answer.
[10 marks]
b) Consider only the information on the 2020 price/earnings multiple of the set of comparable companies. What is the conclusion about the relative valuation of company A? Explain your answer.
[10 marks]
c) Why is the expected dividend growth rate a relevant fundamental variable to take into account when using the price/earnings multiple? Explain your answer.
[10 marks]
Question 4
Suppose that company A is evaluating the acquisition of company B. The expected level of synergies from the deal is 400. After completing the valuation exercise, company A concluded that the fair value of company B is 1200. However, company B shareholders’ asking price is 1350. At this price, the acquisition of company B would be value destructive for company A. Do you agree? Explain your answer.
[10 marks]
2022-01-06