Name:______________________________________ Id.

No:____________________

Birla Institute of Technology and Science, Pilani

First Semester: 2023-2024
Comprehensive Exam (Regular)
PART A

Course Name & No.: Business Analysis and Valuation (ECONF355)

Maximum Marks: 75 (20%) Date: 8 Dec 23
Duration: 60 Minutes Type: Closed Book

Instructions for the students

 Write your name and BITS ID No in the space provided at the top of this page
 This paper consists of 30 multiple-choice questions (choose the most appropriate answer; 2.5 marks each)
There is no negative marking.
 Write your answers in the table provided below. Answers written elsewhere or in incorrect order will not be
evaluated. Overwritten/ambiguous answers will not be evaluated.
 Unreasonable assumptions will be penalized.
 In all the analytical questions mark the closest value

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

B B A A D A D D A A D B A C D C C B

19 20 21 22 23 24 25 26 27 28 29 30

D A C C D B C A C A C A

1. You work for a pharmaceutical company that has developed a new drug. The patent on the drug
will last for 17 years. You expect that the drug will produce cash flows of $10 million in its first year
and that this amount will grow at a rate of 4% per year for the next 17 years. Once the patent expires,
other pharmaceutical companies will be able to produce generic equivalents of your drug and
competition will drive any future profits to zero. If the interest rate is 12% per year, then the present
value of producing this drug is closest to:
A) $71 million B) $90 million C) $170 million D) $105 million

2. Your son is about to start kindergarten in a private school. Currently, the tuition is $12,000 per year,
payable at the start of the school year. You expect annual tuition increases to average 6% per year over
the next 13 years. Assuming that your son remains in this private school through high school and that
your current interest rate is 6%, then the present value of your sonʹs private school education is closest
to:
A) $106,230 B) $156,000 C) $137,900 D) This problem cannot be solved.

3. Henry Rearden is saving for retirement and has determined that to live comfortably he must save $3
million by his 65th birthday. Henry just turned 30 today, and he has decided that starting today and
continuing on every birthday up to and including his 65th birthday, he will deposit the same amount
into an individual retirement account (IRA). If Henry can earn 8% on his IRA, then the amount he must
set aside each year to make sure that he will have $3 million in his account on his 65th birthday is
closest to:
A) $16,035 B) $17,410 C) $83,335 D) $85,715

4. Your company has received a $50,000 loan from an industrial finance company. The annual payments are
$6,202.70. If the company is paying 9% interest per year, how many loan payments must the company make?
A) 15 B) 13 C) 12 D) 19

5. When comparing annuity due to ordinary annuities, annuity due annuities will have higher
A) present values B) annuity payments C) future values D) both A and C E) all of the above .
6. Gina Dare, who wants to be a millionaire, plans to retire at the end of 40 years. Gina's plan is to invest her money
by depositing into an IRA at the end of every year. What is the amount that she needs to deposit annually in order
to accumulate $1,000,000? Assume that the account will earn an annual rate of 11.5%. Round off to the nearest
$1.
A) $1,497 B) $5,281 C) $75 D) $3,622

7. Francis Peabody just won the $89,000,000 California State Lottery. The lottery offers the winner a choice of
receiving the winnings in a lump sum or in 26 equal annual installments to be made at the beginning of each year.
Assume that funds would be invested at 7.65%. Francis is trying to decide whether to take the lump sum or the
annual installments. What is the amount of the lump sum that would be exactly equal to the present value of the
annual installments? Round off to the nearest $1.
A) $89,000,000 B) $38,163,612 C) $13,092,576 D) $41,083,128

8. You are considering investing in a firm that has the following possible outcomes:
Economic boom: probability of 25%; return of 25%
Economic growth: probability of 60%; return of 15%
Economic decline: probability of 15%; return of -5%
What is the standard deviation of returns on the investment?
A) 84.75% B) 15.28% C) 12.47% D) 9.21

9. You are considering buying some stock in Continental Grain. Which of the following is an example of non-
diversifiable risk?
A) Risk resulting from a general decline in the stock market
B) Risk resulting from a news release that several of Continental's grain silos were tainted
C) Risk resulting from an explosion in a grain elevator owned by Continental
D) Risk resulting from an impending lawsuit against Continental

10. Which of the following is NOT a way that a firm can increase its dividend?
A) By increasing its retention rate
B) By decreasing its shares outstanding
C) By increasing its earnings (net income)
D) By increasing its dividend payout rate

11. Which of the following statements is FALSE?

A) Estimating dividends, especially for the distant future, is difficult.
B) A firm can only pay out its earnings to investors or reinvest their earnings.
C) Successful young firms often have high initial earnings growth rates.
D) According to the constant dividend growth model, the value of the firm depends on the current dividend
level, divided by the equity cost of capital plus the growth rate.

12. You expect KT Industries (KTI) will have earnings per share of $3 this year and expect that they will pay out
$1.50 of these earnings to shareholders in the form of a dividend. KTIʹs return on new investments is 15% and
their equity cost of capital is 12%. The expected growth rate for KTIʹs dividends is closest to:
A) 6.0% B) 7.5% C) 4.5% D) 3.0%

13. JRN Enterprises just announced that it plans to cut its dividend from $2.50 to $1.50 per share and use the extra
funds to expand its operations. Prior to this announcement, JRNʹs dividends were expected to grow at 4% per
year and JRNʹs stock was trading at $25.00 per share. With the new expansion, JRNʹs dividends are expected to
grow at 8% per year indefinitely. Assuming that JRNʹs risk is unchanged by the expansion, the value of a share
of JRN after the announcement is closest to:
A) $25.00 B) $15.00 C) $31.25 D) $27.50

14. You expect that Bean Enterprises will have earnings per share of $2 for the coming year. Bean plans to retain all
of its earnings for the next three years. For the subsequent two years, the firm plans on retaining 50% of its
earnings. It will then retain only 25% of its earnings from that point forward. Retained earnings will be invested
in projects with an expected return of 20% per year. If Beanʹs equity cost of capital is 12%, then the price of a
share of Beanʹs stock is closest to:
A) $17.00 B) $10.75 C) $27.75 D) $43.50

15. MI has a $1,000 par value, 30-year bond outstanding that was issued 20 years ago at an
annual coupon rate of 10%, paid semiannually. Market interest rates on similar bonds are 7%. Calculate the
bond's price.
A) $956.42 B) $1,000.00 C) $1,168.31 D) $1,213.19
16. Incremental cash flows from a project =
A) Firm cash flows without the project plus or minus changes in net income.
B) Firm cash flows with the project plus firm cash flows without the project.
C) Firm cash flows with the project minus firm cash flows without the project.
D) Firm cash flows without the project plus or minus changes in revenue with the project.

17. Which of the following is NOT part of a project's initial cash outflow?
A) The asset's purchase price
B) Funds committed to support increased inventory levels due to expected increased sales if the firm adopts
the project
C) A marketing survey completed last year to determine the project's feasibility
D) Expenses incurred to install the asset

18. Which of the following is NOT considered in the calculation of incremental cash flows?
A) Depreciation tax shield B) Sunk costs C) Opportunity costs D) Both A and B

19. Which of the following cash flows should be included as incremental costs when evaluating capital projects?
A) Investment in working capital that is directly related to a project
B) Expenses that are incurred in order to modify a firm's production facility in order to invest in a project
C) Opportunity costs that are directly related to a project
D) All of the above

20. J&P Accounting purchased new tax software two years ago. The software is still useable, but faster, more
comprehensive software is available. If J&P purchases the new software, the cost of the old software is
A) a sunk cost B) an opportunity cost C) a terminal expense D) an overhead expense

21. Thaler & Co. anticipates an increase of $1,000,000 in Net Operating Income from first year sales of a new
product. Taxes will be $350,000 and the company took $150,000 in depreciation expense. Operating cash flow
equals
A) $1,000,000 B) $500,000 C) $800,000 D) $650,000

22. Schiller Construction Inc. has estimated the following revenues and expenses related to
phase I of a proposed new housing development. Incremental sales= $5,000,000, total cash
operating expenses $3,500,000, depreciation $500,000, taxes 35%, interest expense, $200,000.
Operating cash flow equals
A) $650,000 B) $1,000,000 C) $1,150,000 D) $975,000.

23. If SuperMart decides to offer a line of groceries at its discount retail outlet, inventories are
expected to increase by $1,200,000, accounts receivable by $300,000 and accounts payable by
$500,000. What is the cash outflow for working capital requirements?
A) $2,000,000 B) $1,700,000 C) $1,500,000 D) $1,000,000

24. XYZ, Inc. is considering adding a product line that would utilize floor space in their
manufacturing plant which is currently used for storage. XYZ will need to rent new storage
space elsewhere. The floor space would be considered a(n)
A) variable cost B) opportunity cost C) sunk cost D) irrelevant cash flow

25. An investor expects to purchase shares of common stock today and sell them after two years. The investor has
estimated dividends for the next two years, D1 and D2, and the selling price of the stock two years from now, P 2.
According to the dividend discount model, the intrinsic value of the stock today is the present value of:
A) Next year’s dividend, D1 B) future expected dividends, D1 and D2 C) Future expected dividends and price-
D1, D2, and P2 D) None of the above

26. In the free cash flow to equity (FCFE) model, the intrinsic value of a share of stock is calculated as:
A) The present value of future expected FCFE B) the present value of future expected FCFE plus net
borrowing C) the present value of future expected FCFE minus fixed capital investment D) the present
value of future expected FCFE plus Depreciation.

27. The market value of equity for a company can be calculated as enterprise value.
A) Minus market value of debt, preferred stock, and short-term investments.
B) Plus market value of debt and preferred stock minus short-term investments.
C) Minus market value of debt and preferred stock plus short-term investments.
D) None of the above.
28. Which of the following statements regarding the calculation of the enterprise value multiple is most likely
correct?
A) Operating income may be used instead of EBITDA.
B) EBITDA may not be used if company earnings are negative.
C) Book value of debt may be used instead of market value of debt.
D) All of the above.

29. An analyst is attempting to value shares of the Dominion Company. The company has just paid a dividend of
$0.58 per share. Dividends are expected to grow by 20 percent next year and 15 percent the year after that. From
the third year onward, dividends are expected to grow at 5.6 percent per year indefinitely. If the required rate of
return is 8.3 percent, the intrinsic value of the stock is closest to:
A) $26.00 B) $27.00 C) $28.00 D) None of the above

30. An analyst makes the following statements: “Use of P/E and other multiples for analysis is not effective because
the multiples are based on historical data and because not all companies have positive accounting earnings.” The
analyst’s statement is most likely:
A) Inaccurate with respect to both historical data and earnings.
B) Accurate with respect to historical data and inaccurate with respect to earnings.
C) Inaccurate with respect to historical data and accurate with respect to earnings.
D) Accurate with respect to both historical data and earnings.

Space for Rough Work

 Birla Institute of Technology and Science, Pilani
First Semester: 2023-2024
Comprehensive Exam (Regular) – 8 December 2023
Course Name & No.: Business Analysis and Valuation (ECONF355)
Maximum Marks: 45 (20%) Type: Open Book Duration: 120 Minutes

PART B
Instructions for the students
1. All the questions to be attempted in the main Answer sheet
2. This Paper Consists of five questions with sub parts
3. Unreasonable assumptions will be penalized.
4. All answers should be clearly numbered. Unnumbered answers will not be evaluated.
5. Use of Calculator is allowed, however, exchange of same is strictly prohibited

Q1. Bron has EPS of $3.00 in 2002 and expects EPS to increase by 21 percent in 2003. EPS are
expected to grow at a decreasing rate for the following five years, as shown in the following table.

2003 2004 2005 2006 2007 2008

Growth rate for 21% 18% 15% 12% 9% 6%
EPS
Net Capital $5.00 $5.00 $4.50 $4.00 $3.50 $1.50
expenditures
per share
In 2008, the growth rate will be 6 percent and is expected to stay at that rate thereafter. Net capital
expenditures (capital expenditures minus depreciation) will be $5.00 per share in 2002 and then
follow the pattern predicted in the table. In 2008, net capital expenditures are expected to be $1.50
and will then grow at 6 percent annually. The investment in working capital parallels the increase
in net capital expenditures and is predicted to equal 25 percent of net capital expenditures each
year. In 2008, investment in working capital will be $0.375 and is predicted to grow at 6 percent
thereafter. Bron will use debt financing to fund 40 percent of net capital expenditures and 40
percent of the investment in working capital. The required rate of return for Bron is 12 percent.

Estimate the value of a Bron share using a FCFE valuation approach? Show all the workings
(FCFE Stream, PV of FCFE Stream, Value per share). [15]

Answer:
The following table develops the information to calculate FCFE per share (amounts are in US
dollars).
2003 2004 2005 2006 2007 2008
Growth rate for EPS 21% 18% 15% 12% 9% 6%
EPS 3.63 4.283 4.926 5.517 6.014 6.374
Capital expenditure per share Investment in WC per
share 5 5 4.5 4 3.5 1.5
Investment in WC per share 1.25 1.25 1.125 1 0.875 0.375
 New debt financing = 40% of (Capital expenditure +
WCInv) 2.5 2.5 2.25 2 1.75 0.75
FCFE = NI - Capital Expenditure - WCInv+ New debt
financing -0.12 0.533 1.551 2.517 3.389 5.249
-
PV of FCFE discounted at 12% 0.107 0.425 1.104 1.6 1.923

Earnings per share for 2002 are $3.00, and the EPS estimates for 2003 through 2008 in the table
are found by increasing the previous year's EPS by that year's growth rate. The net capital
expenditures each year were specified by the analyst. The increase in working capital per share is
equal to 25 percent of net capital expenditures. Finally, debt financing is 40 percent of that year's
total net capital expenditures and investment in working capital. For example, in 2003, the per-
share amount for net capital expenditures plus investment in working capital is $5.00 + $1.25 =
$6.25. Debt financing is 40 percent of $6.25, or $2.50. Debt financing for 2004 through 2008 is
found in the same way.
FCFE equals net income minus net capital expenditures minus investment in working capital plus
new debt financing. Notice that FCFE is negative in 2003 because of large capital investments and
investments in working capital. As these investments decline relative to net income, FCFE
becomes positive and substantial.
The present values of FCFE from 2003 through 2007 are given in the bottom row of the table.
These five present values sum to $4.944 per share. Because FCFE from 2008 onward will grow at
a constant 6 percent, the constant-growth model can be used to value these cash flows.

𝐹𝐶𝐹𝐸2008 5.249
𝑉2007 = = = $87.483
𝑅−𝐺 0.12 − 0.06

The present value of this stream is $87.483/(1.12)5 = $49.640. The value per share is the present
value of the first five FCFES (2003-2007) plus the present value of the FCFE after 2007, or $4.944
+ $49.640 = $54.58.

Q2. Joe just inherited the family business, and having no desire to run the family business, he has
decided to sell it to an entrepreneur. In exchange for the family business, Joe has been offered an
immediate payment of $100,000. Joe will also receive payments of $50,000, $50,000, $75,000 in
the next three years respectively. The current market rate of interest for Joe is 6%.
In terms of present value, how much will Joe receive for selling the family business? [5]

Answer: PV = $100,000 + $50,000/(1.06)1 + $50,000/(1.06)2 + $75,000/(1.06)3 = $254,641

Q3. Tara Whitney was interested in controlling her company’s inventory because she knew that
excess inventories were expensive in that they tied up funds. On the other hand, insufficient
inventory levels could result in lost sales. Whitney obtained the following inventory information
from her trade association, which reported average figures for companies similar to hers:
Days’ inventory 38 days
Inventory turnover 11 times
Whitney had the following information from last year, which she considered to be a typical year
for her company:
Cost of sales $300,000
Beginning inventory 58,160
Ending Inventory 62,880
Required:
How does Tara Whitney’s company’s inventory compare with that of other similar companies?
Show your workings? [5]

Answer:

($58,160  $62,880)
Average inventory 
2
= $60,520
$60,520
Days' inventory 
($300,000 / 365)

$60,520

$822
= 74 days
$300,000
Inventory turnover 
$60,520
= 5 times

Ms. Whitney’s utilization of her investment in inventory is lower than for similar
companies.

Q4. Aayka Company’s current capital structure is comprised of 30% debt and 70% equity (based
on market values). Aayka equity beta (based on its current level of debt financing) is 1.20, and its
debt beta is 0.29. Also, the risk-free rate of interest is currently 4.5% on long-term government
bonds. Aayka’s investment banker advised the firm that, according to her estimates, the market
risk premium is 5.25%.
a. What is your estimate of the cost of equity capital for Aayka (based on the CAPM)? [2]
b. If the Aayka marginal tax rate is 35%, what is the firm’s overall weighted average cost of
capital (WACC)? [Use CAPM for estimating both Kd and Ke] [2]
c. Aayka is considering a major expansion of its current business operations. The firm’s
investment banker estimates that Aayka will be able to borrow up to 40% of the needed
 funds and maintain its current credit rating and borrowing cost. Estimate the WACC for
this project. [4]

Answer:

Q5. Wilhelm Muller, analyst, has organized the selected data on four food companies that appear
below (TTM stands for trailing 12 months): [12]

Measure Hoppelli Foods Telli Foods Drisket Co. Whiteline Foods

Stock Price $25.70 $11.77 $23.65 $24.61
Shares Outstanding 138,923 220,662 108,170 103,803
(Thousands)
Market cap($Millions) 3,570 2,597 2,558 2,555
EV ($Millions) 3,779 4,056 3,846 4,258
Sales ($Millions) 4,124 10,751 17,388 6,354
Operating Income 285 135 186 396
($Millions)
Operating Profit Margin 6.91% 1.26% 1.07% 6.23%
Net Income ($Million) 182 88 122 252
TTM EPS $1.30 $0.40 $1.14 $2.43
ROE 19.20% 4.10% 6.40% 23.00%
Net Profit Margin 4.41% 0.82% 0.70% 3.97%

Required
A. Calculate the trailing P/E and EV/Sales for each company.
B. Explain, on the basis of fundamentals, why these stocks have different EV/S multiples.
(concise your answer in 70 words only).
 Answer:

A. The P/Es are:

Hoppelli 25.7/1.3 = 19.8
Telli 11.77/0.4 = 29.4
Drisket 23.65/1.14 = 20.7
Whiteline 24.61/2.43 = 10.1
The EV/S multiples for each company are:
Hoppelli 3.779/4.124 = 0.916
Telli 4056/10, 751 = 0.377
Drisket 3.846/17.388 = 0.221
Whiteline 4 ,258/6,354=0.670

B. The data for the problem include measures of profitability, such as operating profit margin,
ROE, and net profit margin. Because EV includes the market values of both debt and
equity, logically, the ranking based on EV/S should be compared with an interest measure
of profitability, namely, operating profit margin. The ranking of the stocks by EV/S from
highest to lowest and the companies' operating margins are:
Operating Profit Margin
Company
EV/S (%)
Hoppelli 0.916 6.91
Whiteline 0.67 6.23
Telli 0.377 1.26
Drisket 0.221 1.07

The differences in EV/S appear to be explained, at least in part, by differences in cost

structure as measured by operating profit margin.