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Peer Review Exercise DT 9-9-24 (6 Stu)

The document presents two peer review exercises involving financial analysis for different companies. The first exercise focuses on estimating discount rates and valuing a division for Tomco Motors and Bestman Kodak, while the second exercise involves estimating cash flows for Diehard Incorporated and Locktreat Corporation. Each problem requires calculations related to cost of capital, cash flows, and valuations based on provided financial data.

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4 views2 pages

Peer Review Exercise DT 9-9-24 (6 Stu)

The document presents two peer review exercises involving financial analysis for different companies. The first exercise focuses on estimating discount rates and valuing a division for Tomco Motors and Bestman Kodak, while the second exercise involves estimating cash flows for Diehard Incorporated and Locktreat Corporation. Each problem requires calculations related to cost of capital, cash flows, and valuations based on provided financial data.

Uploaded by

singhvip1612
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Your Name _____________________

Peer Name _____________________

Peer Review Exercises

PEER 1

Problem 1. Estimation of Discount Rates: WACC Calculation

Tomco Motors has 710 million shares trading at $55 per share and $69 billion in debt outstanding
(with a market value of $65 billion), on which it incurred an interest expense of $5 billion in the most
recent year. The stock has a beta of 1.10 and is rated A (which commands a spread of 1.25% over the
treasury bond rate of 6.25%). The company faced a corporate tax rate of 40%. The company pays a
market risk premium of 5.5%.

What is the cost of equity for TM?


What is the after-tax cost of debt for TM?
What is the cost of capital?

Problem 2. Valuing a Division: Bestman Kodak

In the face of disappointing earnings results and increasingly assertive institutional stockholders,
Bestman Kodak was considering a major restructuring in 1993. As part of this restructuring, it was
considering the sale of its health division, which earned $560 million in earnings before interest and
taxes in 1993, on revenues of $5.285 billion. The expected growth in earnings was expected to
moderate to 6% between 1994 and 1998, and to 4% after that. Capital expenditures in the health
division amounted to $420 million in 1993, while depreciation was $350 million. Both are expected to
grow 4% a year in the long term. Working capital requirements are negligible.

The average beta of firms competing with Kodak's health division is 1.15. While Kodak has a debt
ratio (D/(D+E)) of 50%, the health division can sustain a debt ratio (D/(D+E)) of only 20%, which is
similar to the average debt ratio of firms competing in the health sector. At this level of debt, the
health division can expect to pay 7.5% on its debt, before taxes. (The tax rate is 40%, and the treasury
bond rate is 7%.) The company pays a market risk premium of 5.5%.

A. Estimate the cost of capital for the division.


B. Estimate the value of the division.
C. Why might an acquirer pay more than this estimated value?

1
Your Name _____________________

Peer Name _____________________

Peer Review Exercises

PEER 2

Problem a. Estimating Cash Flows: Diehard Incorporated


Diehard Incorporated manufactures, markets, and services automated teller machines in the United
States. The following are selected numbers from the financial statements for 1992 and 1993 (in
millions):

1992 1993
Revenues $544.0 $620.0
(Less) Operating Expenses ($465.1) ($528.5)
(Less) Depreciation ($12.5) ($14.0)
= Earnings before Interest and
$66.4 $77.5
Taxes
(Less) Interest Expenses ($0.0) ($0.0)
(Less) Taxes ($25.3) ($29.5)
= Net Income $41.1 $48.0
Working Capital $175.0 $240.0

The firm had capital expenditures of $15 million in 1992 and $18 million in 1993. The working
capital in 1991 was $180 million.

Estimate the cash flows to equity in 1992 and 1993.


What would the cash flows to equity in 1993 have been if working capital had remained at the same
percentage of revenue it was in 1992.

Problem b. FCFF Model: Locktreat Corporation

Locktreat Corporation, one of the largest defense contractors in the U.S., reported EBITDA of $1290
million in 1993, prior to interest expenses of $215 million and depreciation charges of $400 million.
Capital Expenditures in 1993 amounted to $450 million, and working capital was 7% of revenues
(which were $13,500 million). Working capital in 1993 was $863 million. The firm had debt
outstanding of $3.068 billion (in book value terms), trading at a market value of $3.2 billion, and
yielding a pre-tax interest rate of 8%. There were 62 million shares outstanding, trading at $64 per
share, and the most recent beta is 1.10. The tax rate for the firm is 40%. (The treasury bond rate is
7%.)

The firm expects revenues, earnings, capital expenditures and depreciation to grow at 9.5% a year
from 1994 to 1998, after which the growth rate is expected to drop to 4%. (Capital spending will
offset depreciation in the steady state period.) The company also plans to lower its debt/equity ratio to
50% for the steady state (which will result in the pre-tax interest rate dropping to 7.5%.)

A. Estimate the value of the firm.


B. Estimate the value of the equity in the firm and the value per share.

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