BA 341

Ch.6 assigned questions

Note: IQ question solutions are at the back of the book.

Ch.6

Investment Quotient (IQ) questions:

3, 10 (treat the dividends in these questions as the cash flow)

Concept questions:

2

Questions and Problems:

1 (dividends = cash flows), 12, 13, 14, 15 (dividends = cash flows),

21, 24

Additional questions:

1. You are trying to determine whether Danold Inc. is appropriately valued using relative valuation. Danold’s current stock price is $25. You collect the following information about Danold and its industry:

DanoldIndustry

Sales ($M)500

Book Value ($M)200

Earnings ($M)80

Shares outstanding (M)50

P/BV5.87

P/S1.83

P/E16.3

Industry betas are similar to that of Danold.

  1. Using P/BV, P/S and P/E, what stock price would you estimate for Danold using each of the multiples?
  2. For each multiple, describe what differences you may find between the firm and the industry that can cause the under- / overvaluation you find in part (a).

2. Use the following inputs to compute a per share value for Southern Trust Bank: Return on Equity will be 15% per year for the next five years after which it is expected to fall to the cost of equity of 10%. The current book value per share is $10. The firm pays no dividends.

3. DeFarm, Inc., has an EBIT of 250 million, depreciation of 90 million, capital expenditures of 170 million and working capital needs of 40 million this year. It has $200m in debt. Cash flows are expected to grow at 3% forever. The firm’s cost of capital is 13%. If the current share price is $20, and there are 10 million shares outstanding, is the company over- or under-valued? Assume a tax rate of 35%.

4. Determine an intrinsic value per share for Taiwan Semiconductor Co. based on the following information: The firm has 5 billion shares outstanding. Sales are currently $5.5 billion. Previous year’s sales was $4.9 billion. EBIT is 32% of Sales. Fixed capital investment is 33% of Sales growth and investment in working capital is 6% of Sales growth, respectively. The firm has $200m in debt and $1 billion in market value of equity. The firm expects to grow sales at the current rate for 2 years after which it will grow its cash flows at 3% forever. The firm’s cost of equity is 10% and cost of debt is 8%. What is the intrinsic value of the firm? Assume a tax rate of 35%.

5. The following is information for Seleca Corp. and its industry.

SelecaIndustry average

Sales500m508m

Profit margin8%16.8%

Earnings growth8%4%

Return on equity17%25%

Cost of equity12%12.2%

Earnings per share$1.60

Stock price$15

  1. You calculate the average P/E multiple for the industry to be 4.69. What can you conclude about Seleca’s current value using this multiple?
  2. What may be a more appropriate relative valuation multiple to use? Why? What can you conclude about Seleca’s current value based on this multiple?