Question 1
An investor is valuing a company that is expected to generate sales from year 1 onwards as given in Table 1.
Table 1
Year 1 Year 2 Year 3 Year 4 Year 5
€35,000 €40,000 €42,500 €48,000 €50,000
Expected EBIT margin (% sales) in year 1 is 7%. Additional assumptions are:
EBIT margin (% sales): decreases 25 basis points (0.25%) per year until year 3, including year 3, and increases 10 basis points (0.10%) per year in years 4 and 5
Depreciation: 6% of sales, each year
Recurrent Capex: 8% of sales for year 1, with this percentage decreasing 50 basis points (0.50%) per year until year 4
Change in working capital: 12% of yearly change of sales
Tax rate: 20%
Target capital structure: debt/(debt + equity) ratio of 60%
Asset beta: 1.10
Risk-free rate: 1%
Equity risk premium: 6%
Debt spread: 3%
To answer the following questions make plausible assumptions if necessary. In case you prefer, standard characters can be used (e.g b rather than β, capital_sigma rather than ∑).
Compute the Free Cash Flows to the Firm (FCF) for the period from year 1 until year 5, including year 5. Explain your answer.
An important characteristic of the FCF model is revealed by the way taxes are estimated when computing the FCF. Which one? Explain your answer.
Do you agree with the following statement: "The FCF model assumes the existence of a stable capital structure."? Explain your answer.
Given the target capital structure and the set of assumptions reported below Table 1, what is the discount rate to be used in this valuation exercise? Explain your answer.
The company is expected to operate beyond year 5 and the expected nominal growth rate of FCF in perpetuity is 2.00%. What is the expected value of the company at the end of year 1? Explain your answer.
Question 2
An asset manager is valuing the company QT at year-end 2021 and is using multiples for that purpose. In Table 2 are disclosed estimated enterprise values of QT at year-end 2021 and year-end 2022, as well as for a set of comparable companies (A, B and C). It is also disclosed in Table 2 estimated EBITDA for years 2021 and 2022 of company QT and comparable companies A, B and C.
Table 2
Enterprise value (estimated) EBITDA (estimated)
Company 2021 2022 2021 2022
QT €22,000 €22,100 €6,200 €7,000
A €12,500 €13,400 €2,800 €3,000
B €40,000 €41,800 €10,000 €11,300
C €32,000 €33,000 €8,500 €9,800
For your answers, round computations to one decimal place (e.g. present 1.56 as 1.6).
What is the 2021 and 2022 enterprise value / EBITDA multiple of company QT and each of its comparable companies? Explain your answer.
Based on the information of the enterprise value/ EBITDA multiple of the set of comparable companies, what is the conclusion about the relative valuation of company QT? Explain your answer.
Consider the following statement: "the nice thing with the use of multiples in the context of a valuation exercise is that they allow to complement the fundamental analysis done with a Discounted Cash Flow model". Do you agree? Explain your answer.
Question 3
Consider the information in Table 3 about an investment opportunity that can be deferred. An investor is studying this investment opportunity.
Table 3
Expected cash flow (CF) year 1 €20 million
g - perpetuity growth rate of CF 1%
k - cost of capital 8%
K - investment cost €300 million
σ - standard deviation of CF 18%
r - risk free rate 2%
δ - opportunity cost 7%
What is the "static" Net Present Value of this investment opportunity? Explain your answer and present the result rounded to one decimal place (example 1.75 to 1.8).
What is the value of this investment opportunity using the Dixit and Pindyck (D&P) model (use the input β = 4.37 in the D&P model)? Explain your answer. Present your result rounded to one decimal place.
Do you agree with the following statement: "This investment opportunity should be rejected by the investor"? Explain your answer.
Attachment:- Free Cash Flows.rar