1.

Solution:

Profit before tax 9200

+ Interest expense + 2600
- Interest income - 1000
- Non – operating income - 1000
9,800

2. FCF= 180000+25000-100000=105000

4. FCFE=55.46-23.56+3.81+1.39+12.42-6.9

Equity reinvested=55.46-FCFE
ERR= Equity Reinvested/ 55.46
G=4.8% (ERR*ROE)

5. 5. COE = .0625 + 1.1 (.055) = .123

i(after-tax cost of debt) = .0645 x (1-.4) = .039
WACC = {(32x1.13)/38.16} x .1230 + {2.0/38.16} x .039 = .1166 + .002 = .119

6. 6. Given: 2/3 x 12% x (1 – 0.33) + 1/3 x r = 14% where r is the cost of equity capital.
Therefore r= (14-5.36) x 3 = 25.92 %
Using the SML equation we get: 8% + 6% x β = 25.92 %
Solving this equation we get β = 2.99

7. Solution::

βA = βE / [ 1 + D/E (1 – T)]

X : 1.1 / [1 + 1.4 ( 1 - 0 .28) ] = 0.548

Y : 1.3 / [ 1 + 1.6 ( 1 – 0.30 ) ] = 0.613
Z : 1.5 / [ 1 + 1.2 ( 1 – 0.30)] = 0.815
Average = 0.659

Solution:
The equity beta for the textile project is:

0.659 [1 + 1.5 (1 – 0.32)] = 1.331

The cost of capital is:

1.5 1.0
x 12 x (1 – 0.32) + [7 + 1.331 (5) ]
2.5 2.5
4.90 + 5.46 = 10.36 %
 8. Solution:

(a) WACC
High growth period
Year Cost of equity Cost of debt WACC
1 7 + 1.3 (6) =14.8% 10 (1 – 0.20) = 8% 2/3 x 14.8 + 1/3 x 8 = 12.5
2 7 + 1.3 (6) = 14.8% 10 (1 – 0.25) = 7.5% 2/3 x 14.8 + 1/3 x 7.5 = 12.4
3 7 + 1.3 (6) = 14.8% 10 (1 – 0.30) = 7 .0% 2/3 x 14.8 + 1/3 x 7.0 = 12.2

Transition period
Cost of equity Cost of debt
WACC
6 + 1.2 (7) = 14.4% 10 (1 – 0.3) = 7% 2/3 x 14.4 +
1/3 x 7 = 11.9

Stable period
Cost of equity Cost of debt
WACC
7 + 1.1 (7) = 14.7% 10 (1 – 0.3) = 7% 1/1.284 x 14.7 + 0.284 /1.284 x 7 = 13.0%

Year
Growth
EBIT
Tax EBIT Capex Deprn WC Δ WC FCF
WACC PV
PV
rate % rate (%) (1 –T) % Factor
0 750 15 500 140 600

1 40 1050 20 840 700 196 840 240 96 12.5 0.889 85.3

2 40 1470 25 1102.5 980 274.4 1176 336 60.9 12.4 0.791 48.2

3 40 2058 30 1440.6 1372 384.2 1646.4 470.4 (17.6) 12.2 0.705 (12.4)

4 34 2757.7 30 1930.4 1838.5 514.8 2206.2 559.8 46.9 11.9 0.630 29.5

5 28 3529.9 30 2470.9 2353.3 658.9 2823.9 617.7 158.8 11.9 0.563 89.4

6 22 4306.5 30 3014.5 2871.0 803.9 3445.2 621.3 326.1 11.9 0.503 164.0

7 16 4995.5 30 3496.8 3330.3 932.5 3996.4 551.2 547.8 11.9 0.450 246.5

8 10 5495.0 30 3846.5 3663.4 1025.7 4396.0 399.6 809.2 11.9 0.402 325.3

9 10 6044.5 30 4231.2 4029.7 1128.3 4835.6 439.6 890.2 13.0 0.356 316.9

(b) Present value of FCF in the high growth period

= 85.3 + 48.2 – 12.4 = Rs.121.1 million
 (c) PV of FCF in the transition period
= 29.5 + 89.4 + 164 .0 + 246.5 + 325.3
= Rs.854.7 million

(d) PV of terminal value

890.2
= x 0.402 = Rs.11928.7 million
0.13 – 0.10

(e) Intrinsic value per share

Value of firm – Value of debt

Number of shares

121.1 + 854.7 + 11928.7 - 300

=
60
= Rs.210.1

9.

a. Beta = 1.6 x 100/500 + 2.00 x 150/500 + 1.2 x 250/500 =1.52

b. COE (software division) = .05 + 2.0 (.055) = 16%
c. COE (entire firm) = .05 + 1.52 (.055) = 13.4%
d, PV (total firm) = $7.4 (1.08) / (.134 - .08) = 7.99/.054 = $148
PV (software division) = $3.1 (1.08) / (.16 - .08) = $3.35 / .08 = $41.85
10.

Balance Sheet Item Book Value of Assets Liquidation Value

Cash $10 $10
Accounts Receivable $20 $14
Inventory $15 $6
Net Fixed Assets, $8 $2.0
Excluding Land
Land $6 $7.2
Total Assets $59 $39.2
Total Liabilities $35 $35
Shareholders Equity $24 $4.2
Liquidation Related $.9 $2.9
Expenses
Cash Available for $1.3
Common Shareholders
Dividend Model

SOLUTION 2

(a) The pay out ratio = 4.2/15 = 0.28 or 28% currently.

Therefore retention ratio = (1 – 0.28) = 0.72 or 72%.
30
Return on Equity = 160 = 0.1875 or 18.75%

Hence, the estimated growth rate in earnings = 0.72  0.1875  0.135 or 13.5%
(b) The growth rate approaches 6% at the end of fifth year.
= 0.5876 or 58.76%
(c) The expected beta at the end of fifth year will depend on leverage ratio prevailing at that point
of time.

Currently, levered beta

L  = 0.85
L
 D 
1  1  T 
So, the unlevered beta =  E 
0.85

=
1  0.05 1  0.385
= 0.82
0.82  1  0.25 1  0.385 
Therefore levered beta during stable growth period is = 0.95
(d) The required rate of return at the end of fifth year would be
7 + 0.95*5.5 = 12.23%
EPS as of now is Rs.15.
Growth rate applicable for first five years is 13.5%
Growth rate during stable period is 6%
Pay-out ratio in stable period is 58.76%
So, at the value of the stock as per Gordon Growth model
= Rs. 282.47
(e) Cost of equity during first five years = 7 + 0.85*5.5 = 11.675%
Dividends in the following years:
Year 1 2 3 4 5 Cumulated from 6th year
onwards
EPS 17.03 19.32 21.93 24.89 28.25
DPS 4.77 5.41 6.14 6.97 7.91 282.47
[email protected]% 4.27 4.34 4.41 4.48 4.55 162.63
Therefore the value of the stock using two-stage dividend discount model is
4.27 + 4.34 + 4.41 + 4.48 + 4.55 + 162.63 = Rs.184.68
(f) If only stable growth was available then the value of the share would have been using Gordon
Growth model
15  1.06  0.5876
0.1223  0.06 = Rs.149.97
Had there been no growth then the value of share would have been
15  05876
0.1223 = 72.07
The value attributed to extraordinary growth = 184.68 – 149.97 = Rs.34.71
The value attributed to stable growth = 149.97 – 72.07 = Rs.77.90