Business Valuation An Integrated Theory 2nd Edition Z. Christopher Mercer, Travis W. Harms - Solutions

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1. You are valuing DistressCo, a company struggling to hold market share.The company currently generates $120 million in revenue but is expected to shrink to $100 million next year. Cost of sales currently equals $90 million, and depreciation equals $18 million.Working capital equals $36 million,
6. You are valuing an industrial firm whose enterprise value is $10.0 billion.The company has no straight debt but does have 100,000 convertible bonds outstanding. The market value of each bond is $1,150. If the company has 500 million shares outstanding, what is the company’s equity value and
5. You are valuing a technology company whose enterprise value is $800 million.The company has no debt but considerable employee options, 10 million in total. Based on option-pricing models, you value each option at $6.67.Assume the average strike price equals $15. If the company has 40 million
4. You are valuing a company that has $200 million in debt using probabilityweighted scenario analysis. You carefully model three scenarios, such that the resulting enterprise value equals $300 million in scenario 1, $200 million in scenario 2, and $100 million in scenario 3. The probabilities of
3. MarineCo has no debt but does have unfunded pension liabilities valued at$200 million, recorded as a long-term other liability. MarineCo has detailed in its annual report a potential legal judgment of $100 million for defective engines. Since management estimates a 90 percent likelihood the
2. MarineCo manufactures, markets, and distributes recreational motorboats.Using discounted free-cash-flow analysis, you value the company’s operations at $2,500 million. The company has a 20 percent stake in a nonconsolidated subsidiary valued at $500 million. The investment is recorded on
1. PhoneCo, a U.S. maker of smart phones and other consumer products, has$60 billion of cash and marketable securities on its balance sheet and revenues of $50 billion. Using the rule of thumb mentioned in the text, how much would you estimate as cash needed for operations and excess cash and
7. What challenges did the financial crisis of 2008 and its aftermath pose for estimating a firm’s cost of capital? How should one handle these challenges?
6. You are analyzing a distressed bond with one year to maturity. The bond has a face value of $100 and pays a coupon rate of 5 percent per year, with annual coupons. The bond is currently trading at $80. What is the yield to maturity on the bond? If the probability of default is 35 percent, what
5. Market betas are typically computed with five years of monthly data or two years of weekly data. For computational simplicity, we present only 12 data points in Exhibit 13.13 for ConglomCo, a large conglomerate firm. Using a spreadsheet regression package or other software tool, compute a
4. Suppose that the median price-to-earnings ratio for the S&P 500 is 15.0. If the long-run return on equity is 13.5 percent and the long-run growth in gross domestic product (GDP) is expected to be 6.7 percent (3.5 percent real growth and 3.2 percent inflation), what is the cost of equity implied
3. Your company, EuropeCo (a German conglomerate of food, beverages, and consumer products), has announced its intention to purchase Bangalore Bread. EuropeCo has the same target capital structure as that of Bangalore Bread in Question 2. If the German risk-free rate is 5 percent and the beta of
2. Bangalore Bread is now considering a leveraged recapitalization of the company.Upon announcement, management expects the share price to rise by 10 percent. If the company raises 200 million rupees in new debt to repurchase shares, how many shares can the company repurchase? Assuming management
1. Bangalore Bread is an Indian producer of breads and other baked goods.Over the past year, profitability has been strong, and the share price has risen from 15 rupees per share to 25 rupees per share. Financial analysts(who generate projections in rupees) expect the profit growth to continue.The
6. SuperiorCo earns a return on invested capital of 20 percent on its existing stores. Given intense competition for new store sites, you believe new stores will earn only their cost of capital. Consequently, you set return on new invested capital (RONIC) (8 percent) equal to the cost of capital (8
5. A colleague suggests that a 6 percent growth rate is too low for revenue, profit, and cash flow growth beyond year 5. He suggests raising growth to 12 percent in the continuing-value period. If NOPLAT equals $26.6 million in year 6, return on new invested capital (RONIC) equals 15 percent, and
4. Since growth is stable for ApparelCo, you decide to start the continuing value with year 3 economic profits (i.e., economic profits in year 3 and beyond are part of the continuing value). Using the economic-profit formula(and data provided in Question 1), what is the continuing value as of year
3. Using the economic-profit formula, what is the continuing value for ApparelCo as of year 5? Using discounted economic profit, what is the value of operations for ApparelCo? What percentage of ApparelCo’s total operating value is attributable to current invested capital, to interim economic
2. Since growth is stable for ApparelCo, you decide to start the continuing value with year 3 cash flows (i.e., cash flows in year 3 and beyond are part of the continuing value). Using the key value driver formula (and data provided in Question 1), what is the continuing value as of year 2? Using
1. Exhibit 12.13 presents free cash flow and economic-profit forecasts for ApparelCo, a $250 million company that produces men’s clothing. ApparelCo is expected to grow revenues, operating profits, and free cash flow at 6 percent per year indefinitely. The company earns a return on new invested
6. The chief financial officer of PartsCo returns and explains that there is a possibility of a huge contract being awarded to the company. If this occurs, then the company is expected to achieve 25 percent revenue growth annually for the next five years. How does this affect the pro forma balance
5. The chief financial officer of PartsCo has asked you to rerun the forecast of the company’s income statement and balance sheet at a growth rate of 3 percent. If the company generates more cash than it needs, how could the balance sheet be adjusted to handle this? What alternatives exist to
4. Using the methodology outlined in Exhibits 11.12 and 11.13, forecast the financing items on next year’s balance sheet for PartsCo. Assume shortterm debt remains at $90 million, long-term debt remains at $210 million, no equity is raised, and the firm maintains the same dividend payout ratio as
3. Using the methodology outlined in Exhibit 11.11, forecast the operating items on the next five years of balance sheets for PartsCo. Forecast each balance sheet item as a function of revenues, except inventory and accounts payable, which should be forecast as a function of cost of sales. Your
2. Exhibit 11.16 presents the income statement and balance sheet for PartsCo, a $1.2 billion supplier of machinery parts. The company is expected to increase revenues by 8 percent annually for the next five years. Using the methodology outlined in Exhibit 11.4 and the template in Exhibit 11.16,
1. HouseholdCo, a large household products firm, recently reported $6.2 billion in accrued and other liabilities and $49.0 billion in revenues, such that accrued and other liabilities equaled 12.6 percent of revenues. Using data from the annual report’s footnote 4, provided in Exhibit 11.15,
6. Which interest coverage ratio, earnings before interest, taxes, depreciation, and amortization (EBITDA) to interest or EBITA to interest, will lead to a higher number?When is the EBITDAinterest coverage ratio more appropriate than the EBITA ratio? When is the EBITA interest coverage ratio more
5. PaperPro had previously acquired PaperExpo, which independently generates$800 million per year in revenues, with no material growth. The consolidated revenues for PaperPro (post-acquisition) are $1.5 billion in year 1,$1.8 billion in year 2 (the year of the acquisition), and $2.5 billion in year
4. You are an equity analyst and have computed the following figures for two manufacturers of paper products. The first, PaperPro, has NOPLAT of $325 million, invested capital without goodwill of $2,500 million, and goodwill of $950 million. The second, ExpertPaper, has NOPLAT of $750 million,
3. Decompose the ratio of operating working capital to sales for ShipCo into operating-cash days, accounts-receivable days, inventory days, accountspayable days, and accrued-expenses days. (For comparability, use sales in all calculations.) Compare these results with those in Exhibit 10.14 for
2. Using the data presented in Question 1, decompose operating margin and capital turnover. What has been occurring at ShipCo over the five-year period?What might be driving these results?
6. Many companies hold significant amounts of excess cash, or cash above the amount required for day-to-day operations. What would happen to the ROIC for HealthCo if you included excess cash in its calculation? Why should one exclude excess cash from the calculation?
5. Using the reorganized financial statements created in Question 4,what is the free cash flow for HealthCo in the current year and next year?
4. Exhibit 9.19 presents the income statement and balance sheet for HealthCo, a $600 million health-care company. Compute NOPLAT, average invested capital, and ROIC for the current year and future year. Assume an operating tax rate of 30 percent. If the weighted average cost of capital is 10
3. Why does the return on equity differ between Company A and Company C? Is this difference attributable to operating performance? Which better reflects operating performance, return on assets or return on equity? Why?
2. Why does the return on assets differ between Company Aand Company B?Why do companies with equity investments tend to have a lower return on assets than companies with only core operations?
1. Exhibit 9.18 presents the income statement and balance sheet for Companies A, B, and C. Compute each company’s return on assets (ROA), return on equity (ROE), and return on invested capital (ROIC). Based on the three ratios, which company has the best operating performance?EXHIBIT 9.18 Ratio
8. Exhibit 8.19 displays key financial information for VidCo, an entertainment firm. Fill in the shaded areas of the exhibit to arrive at a value of the operations using the adjusted present value model. Assume that the interest tax shields are as risky as the overall firm.EXHIBIT 8.19 VidCo: Key
7. Using the information from Exhibit 8.18 and calculations from Question 1, calculate BrandCo’s equity value using the cash-flow-to-equity model. How does your valuation compare with your answers in Questions 4 and 6?
6. Using the economic profit for years 1 to 5 calculated in Question 5, an estimated continuing value at the end of year 5, and the weighted average cost of capital computed in Question 2, value BrandCo using the economic-profitbased key value drivermodel.Assume a long-term growth rate in cash
5. What are the three components required to calculate economic profit? Determine BrandCo’s economic profit in years 1 to 6.
4. Assuming the market value of debt equals today’s book value of debt, what is the intrinsic equity value for BrandCo?What is the value per share? Does it differ from the share price used to determine the cost-of-capital weightings in Question 2?
3. Using the next five years of free cash flow computed in Question 1, an estimated continuing value at the end of year 5, and the weighted average cost of capital computed in Question 2, estimate BrandCo’s enterprise value.Assume a long-term growth rate in cash flows of 5 percent and a return on
2. BrandCo currently has 65.6 million shares outstanding. If BrandCo’s shares are trading at $57 per share, what is the company’s market capitalization(value of equity)? Assuming the market value of debt equals today’s book value of debt, what percentage of the company’s value is
1. Exhibit 8.18 displays the income statement and reorganized balance sheet for BrandCo, a consumer products company. Using the methodology outlined in Exhibit 8.5, determine net operating profit less adjusted taxes (NOPLAT)for years 1 to 6. Assume an operating tax rate of 30 percent. Using the
8. Discuss why, within the broader health care sector, ROIC can be declining for health-care facility companies but increasing for health-care equipment companies.
7. In Exhibit 6.8, the gradual decline in ROIC of the top-performing companies can be explained by gradual erosion of competitive advantages. What could be the explanation for the gradual increase in ROIC of the bottom performing companies?
6. Explain the difference between ROICs excluding and ROICs including goodwill for U.S. companies: what does this difference imply, and why has it increased so much over the past decade?
5. Discuss potential explanations for the increase in median ROIC and the widening of the distribution of ROICs across all companies over recent decades.
4. Why are competitive advantages based on brands, as in the consumer goods industry, often more important for long-term value creation than advantages based on product quality or innovation?
3. Why do companies operating within the pharmaceutical and biotechnology industries typically sustain higher ROICs than firms in the hardware and equipment industries?
2. Identify and discuss real examples of companies with a competitive advantage based on customer lock-in as opposed to product innovation. Which type of competitive advantage do you expect to sustain a high ROIC for a longer time?
1. From a value-creation perspective, is it more important for a company to know where to compete or how to compete? That is, is it more important to play in the right markets or to be the best player in your current markets?
14. Some firms chose not to expense employee stock options until accounting rules required all firms to do so, while other firms chose to expense options even before being required to do so. What was the impact on financials for firms that chose to expense options? What was the impact on their
13. What do executives believe are the benefits of issuing EPS guidance? Do companies actually realize these benefits?
12. Certain agencies often categorize company shares as growth stocks or value stocks. What is the difference between growth and value stocks? Why are these labels misleading?
11. Why do noise traders have limited impact on a company’s share price even when they make the largest volume of trades in the company’s stock over a given time period?
10. Would a company’s share price benefit fromhaving fewer traders andmore fundamental investors among the company’s shareholders? Why or why not?
9. Why do executives spend so much time and effort on communicating with noise traders if intrinsic investors ultimately drive a company’s share price?
8. Why is it much riskier to take a short position in a stock than a long position? What does that mean for the likelihood of overvaluation versus undervaluation of a company’s share price?
7. Over the past five years, the highest share price for HighTechCo, a 15-yearold software company, was around $650, and its lowest price was around$150. BrandCo, a consumer products firm with a 70-year history, had share prices ranging from $85 down to $40 over the same period. Do such wide ranges
6. As a rule, cross-listings for companies with a home listing in a mature capital market do not offer material benefits. Discuss how and why this might be different for companies based in emerging capital markets.
5. In inflationary periods for input prices, what happens to earnings when firms change from first-in first-out (FIFO) to last-in first-out (LIFO) inventory accounting? How does the market react? Why is this the case?
4. Empirical research shows that goodwill impairments have no impact on a company’s share price. But these impairments do reflect an auditor’s best estimate of the value lost in an acquisition by the company. Does the stock market not care about such losses? Explain.
3. If a company’s value is not driven by its short-term earnings, why do investors spend so much time analyzing a company’s annual or even quarterly earnings announcements?
2. Many corporate executives focus on earnings per share (EPS) and attempt to manage reported earnings in order to meet analysts’ expectations. Can managers succeed in protecting the stock price of their company by managing these accounts?Why or why not?
1. Explain how long-term price-to-earnings (P/E) ratios in the U.S. stockmarket of around 15 times are consistentwith long-term expected stock returns of around 6 to 7 percent a year in real terms.
8. If growth from gaining market share through product promotion and pricing rarely creates much value, why domost consumer goods companies put so much effort into it?
7. Discusswhy the ranking of industries by growth varies more over time than their ranking by ROIC.
6. Why do company growth rates typically converge much more quickly toward the average rate across all companies than their rates of ROIC, given that both ultimately depend on the underlying product life cycles?
5. Why do fast-growing companies typically fail to sustain their high growth rates?
4. Identify and discuss an example where growth in market share through a price war created long-term value for a company.
3. Why could growth through a series of bolt-on acquisitions createmore value than growth through a single large acquisition? (Consider premium paid and synergies created for each individual transaction.)
2. For which type of company is additional growth likely to create more value:a high-ROIC company in amaturemarket or a low-ROIC company in a fastgrowing market? Give reasons for your answer.
1. Discuss the three generic sources of a company’s growth, their relative importance for its growth, and the implications for a company’s strategy.
7. What more could boards of directors and shareholders do to ensure that managers pursue long-term value creation?
6. If growth is a significant value driver, does getting bigger translate into creating value? Explain.
5. What are some of the common features of the 2008 stock market crash and previous market crashes—for example, Japan’s in the 1990s or the Internet bubble around the turn of the millennium?
4. Give examples of situations where shareholders’ and other stakeholders’interests are complementary. Give examples of situations where these interests are not complementary. If interests conflict, what should management do?
3. When managers and boards of directors evaluate firm performance, how might focusing exclusively on corporate earnings lead them astray?
2. Why is maximizing current share price not equivalent to maximizing long-term value?
1. What benefits does a long-term perspective on value creation offer for companies?For the economy?
Is the QMDM overly sensitive to changes in assumptions?
How can the reasonableness of the estimated required holding period return be evaluated?
What specific factors contribute to holding period premiums?
How does the expected growth in value for public and private companies differ?
How are distributions from S corporations compared to dividends from C corporations?
What factors should be considered in assessing the expected holding period?
Does the expected holding period depend on the characteristics of the subject interest or the current owner of the subject interest?
Providing practical guidance for appraisers to assist in developing assumptions in specific valuation situations.
Examining the sensitivity of conclusions drawn from the QMDM to changes in the assumptions made by business appraisers.
Illustrating the relative importance of each assumption in developing marketability discounts for nonmarketable minority interests of business enterprises.
Discussing the background and rationale for each of the assumptions.
Are agency costs a component of the minority interest discount or marketability discount?
What economic factors contribute to the difference in value between the enterprise and shareholder levels of value?
What are the inputs to a shareholder level discounted cash flow analysis?
What approaches to valuation should the appraiser consider at the shareholder level?
What are the sources of value at the shareholder (i.e., nonmarketable minority interest) level of value?
What is the conceptual relationship between the discount rates at the marketable minority (Rmm) and nonmarketable minority (Rhp) levels of value?
What are the practical differences, if any, between the discount rates for strategic control investors (Rs) and financial control investors (Rf )and marketable minority investors (Rmm)?

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Business Valuation An Integrated Theory 2nd Edition Z. Christopher Mercer, Travis W. Harms - Solutions

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