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Cass Undergraduate School

FR2203 Company Valuation
Part 2 Examination

28 April 2011 14:30 16:45
Important note for students regarding past exam papers
Past exam papers are published for illustrative purposes only. They can be used as a study aid
but do not provide a definitive guide to either the format of the next exam, the topics that will be
examined or the style of questions that will be set. Students should not expect their own exam to
be directly comparable with previous papers. Remember that a degree requires an amount of
self-study, reading around topics, and lateral thinking particularly at the higher level modules
and for higher marks. Specific guidance for your exam will be given by the lecturer.

Instructions to students:
Answer ALL QUESTIONS IN BOTH SECTIONS (A & B)
Section A has 20 multiple choise questions & Section B has 3 questions.

The number of marks allocated is shown at the beginning of each section and at the end
of each question.

ANSWER MULTIPLE CHOICE QUESTIONS ON THE OPTICAL SCANNING SHEET
ONLY.

This examination paper consists of 14 printed pages including the title page.

Materials:
Number of answer books to be provided: 1
Multiple Choice Answers Sheet
Only the Casio calculators FX-83 or FX-85 (MS or ES or GT+) are permitted for use in this
Internal Examiner: Mr Kostas Andriosopoulos
exam
Dictionaries are not permitted.
Formulae sheets and Normal Distribution table are attached at the back of this exam
paper.
This examination paper may be removed from the examination room.


External Examiner: Dr George Alexandrou
BSc (Hons) Degree in Banking and International Finance
BSc (Hons) Degree in Investment & Financial Risk Management
BSc (Hons) Degree in Investment Analysis & Insurance
BSc (Hons) Degree in Real Estate Finance & Investment

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SECTION A
(Answer all Questions on MCQ answer sheet) (50 Marks; 2.5 marks per
question)
Question 1
Super Computer Company's stock is selling for $100 per share today. It is
expected that this stock will pay a dividend of 6 dollars per share, and then be
sold for $114 per share at the end of one year. Calculate the expected rate of
return for the shareholders.
a. 20%
b. 15%
c. 10%
d. 25%
Question 2
How much are you willing to pay for one share of stock if the company just paid
an $.80 annual dividend, the dividends increase by 4% annually and you require
an 8% rate of return?
a. $19.23
b. $20.00
c. $20.40
d. $20.80
Question 3
Cant Hold Me Back, Inc. is preparing to pay its first dividends. It is going to pay
$1.00, $2.50, and $5.00 a share over the next three years, respectively. After
that, the company has stated that the annual dividend will be $1.25 per share
indefinitely. What is this stock worth to you per share if you demand a 7% rate of
return?
a. $7.20
b. $14.48
c. $18.88
d. $21.78



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Question 4
The Wall Street J ournal quotation for a company has the following values: Div:
$1.12, PE: 18.3, Close: $37.22. Calculate the dividend pay-out ratio for the
company.
a. 18%
b. 55%
c. 45%
d. None of the above
Question 5
The constant dividend growth formula assumes:
I. the dividends are growing at a constant rate g forever
II. r >g
III. g is never negative.
a. II only
b. II and III only
c. I and II only
d. I, II and III

Question 6
General Electric (GE) has about 10.3 billion shares outstanding and the stock
price is $37.10. The P/E ratio is about 18.3. Calculate the market capitalization for
GE. (Approximately)

a. $679 billion
b. $188 billion
c. $382 billion
d. None of the above
Question 7
The upper limit for the value of a call option is equal to:
a. The strike price minus the initial cost of the option.
b. The exercise price plus the price of the underlying stock.
c. The underlying price minus the strike price.
d. The price of the underlying stock.



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Question 8
A growth stock portfolio and a value portfolio might be characterized:

a. Each by their P/E relative to the average P/E; high P/E for growth and
lower for value.
b. As earning a high rate of return for a growth security and a low rate of
return for value security irrespective of risk.
c. Low unsystematic risk and high systematic risk, respectively.
d. Moderate systematic risk and zero systematic risk, respectively.

Question 9
Universal Air is a no growth firm and has two million shares outstanding. It is
expected to earn a constant 20 million per year on its assets. If all earnings are
paid out as dividends and the cost of capital is 10%, calculate the current price
per share for the stock.

a. $150
b. $50
c. $200
d. $100

Question 10
The value of a stock:

a. Increases as the required rate of return decreases
b. Increases as the required rate of return increases
c. Increases as the dividend growth rate increases
d. Both A and C
Question 11
Suppose the MiniCD Corporation's common stock has a return of 12%. Assume
the risk-free rate is 4%, the expected market return is 9%, and no unsystematic
influence affected Mini's return. The beta for MiniCD is:

a. 0.89.
b. 1.60.
c. 2.40.
d. It is impossible to calculate beta without the inflation rate.






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Question 12
The stock of Big J oes has a beta a 1.14 and an expected return of 11.6%. The
risk-free rate of return is 4%. What is the expected return on the market?

a. 7.60%
b. 8.04%
c. 9.33%
d. 10.67%

Question 13
Casino Inc. is expected to pay a dividend of $3 per share at the end of year 1
(D1) and these dividends are expected to grow at a constant rate of 6% per year
forever. If the required rate of return on the stock is 18%, what is current value of
the stock today?

a. $25
b. $50
c. $100
d. $54

Question 14
The growth rate in dividends is a function of two ratios. They are:

a. ROA and ROE
b. Dividend yield and growth rate in dividends
c. ROE and the Retention Ratio
d. Book value per share and EPS

Question 15
Company X has a P/E ratio of 10 and a stock price of $50 per share. Calculate
earnings per share of the company.

a. $6 per share
b. $10 per share
c. $0.20 per share
d. $5 per share


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Question 16
Weisbro and Sons common stock sells for $21 a share and pays an annual
dividend that increases by 5% annually. The market rate of return on this stock is
9%. What is the amount of the last dividend paid by Weisbro and Sons?

a. $.77
b. $.80
c. $.84
d. $.87
Question 17
The price of a stock is:
a. the future value of all expected future dividends, discounted at the dividend
growth rate.
b. the present value of all expected future dividends, discounted at the
dividend growth rate.
c. the future value of all expected future dividends, discounted at the
investors required return.
d. the present value of all expected future dividends, discounted at the
investors required return.

Question 18
High beta projects are projects with _________ risk and should be evaluated
using a __________ cost of equity capital.
a. low; low
b. low; high
c. high; high
d. high; low

Question 19
Consider a binomial world in which the current stock price of 80 can either go up
by 10 percent or down by 8 percent. The risk-free rate is 4 percent. Assume a
one-period world. Answer the next 2 questions about a call with an exercise price
of 80.

What would be the call's price if the stock goes up?

a. 3.60
b. 8.00
c. 5.71
d. none of the above
Page 7 of 14
Question 20
What would be the call's price if the stock goes down?
a. 8.00
b. 3.60
c. 0.00
d. 9.00






















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SECTION B (Answer All Questions) (50 Marks)

Question 21
Nu-Tek, Inc. is expecting a period of intense growth and has decided to retain
more of its earnings to help finance that growth. As a result it is going to reduce
its annual dividend by 10% a year for the next three years. After that, it will
maintain a constant dividend of $.70 a share. The last dividend paid by the
company was $1.80 per share. What is the value of this stock if the required rate
of return is 13%?
(10 marks)
Question 22
Answer all
(i) What is the risk-premium on the market? (3 marks)
parts of this question.
The Treasury-Bill rate is 5 percent, and the expected return on the market
portfolio is 12%. On the basis of the Capital Asset Pricing Model:
(ii) What is the required return on an investment with a beta of 1.5?
(4 marks)
(iii) If an investment with a beta of 0.8 offers an expected return of 9.8
percent, is it overpriced or underpriced? (4 marks)
(iv) If the market expects a return of 11.2 percent from Stock X, what is
its beta? (4 marks)

(Total: 15 marks)










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Question 23
Answer all

parts of this question.

Revex operates a chain of pharmacies around the country. You have been
provided with the following projections for the firm (in millions of USD).

1 2 3 4 (Terminal
Year)
EBIT $100 $125 $156.25 $164.06
Net Cap Ex 30 37.5 46.5 32
Total Working
Capital
60 70 82 88
Cost of Equity 12% 11% 11% 10%
Pre-tax cost of
borrowing
8% 7.5% 7% 7%
Debt to
Capital Ratio
25% 25% 25% 25%




The firm has a marginal tax rate of 40%, but it has net operating losses of $175
million that is carrying forward. The firm will grow at 5% forever, starting in year 4.
The working capital currently is $52 million.
a. Estimate the effective tax rate for the next 4 years.
(5 marks)
b. Estimate the expected cash flows to the firm for the next 3 years.
(7 marks)
c. Estimate the cost of capital each year for the next 3 years.
(5 marks)
d. Estimate the terminal value at the end of year 3.
(3 marks)
e. Estimate the value of the firm today.
(5 marks)

(Total: 25 marks)



Page 10 of 14
Formulae Sheet

n = t
1 = t
t
r) + (1
t
CF
= Value

E(R) =Rf + (Rm- Rf)

L =u (1+((1-t)D/E))

L =u (1+((1-t)D/E)) - debt (1-t) (D/E)

Cash Flow to the firm: =EBIT (1 - tax rate)
- (Capital Expenditures - Depreciation)
- Change in Working Capital

Cash Flow to equity =Net Income
- (Capital Expenditures - Depreciation)
- Changes in non-cash Working Capital
- (Principal Repayments - New Debt Issues)

Retention Ratio =Retained Earnings/ Current Earnings

ROE =Net Income/Book Value of Equity

gEPS =Retention Ratio * ROE

ROC =EBITt (1 - tax rate) / Book value of Capitalt-1

Reinvestment Rate =(Net Capital Expenditures +Change in WC)/EBIT(1-t)

Return on Investment =ROC =EBIT (1-t)/(BV of Debt +BV of Equity)

gEBIT =(Net Capital Expenditures +Change in WC)/EBIT(1-t) * ROC
=Reinvestment Rate * ROC





Call =Borrowing +Buying D of the Underlying Stock
Put =Selling Short D on Underlying Asset +Lending

Value of Call =Current Value of Underlying Asset*Option Delta
- Borrowing needed to replicate the option

Value of call =S N (d1) - K e-rt N(d2)

P 0 =
DPS t
(1+r)
t

t=1
t=n
+
P n
(1+r)
n
-
DPS 0 *(1+g n )
(r- g n )
+
DPS 0 *(1+g n )
(r- g n )
-
DPS 0
r
+
DPS 0
r
Page 11 of 14
t
t )
2
+ (r +
K
S
ln
= d
2
1

|
.
|

\
|

d2 =d1 - t

n
1
0
g r
DPS
P

=

n
n
0
0
-g r
) g (1 * Ratio Payout
= PE
EPS
P +
=

n
n
0
0
-g r
) g (1 * ings) (FCFE/Earn
= PE
EPS
P +
=

n
n
n
n
n 0
n
n
0
0
r) + )(1 g - (r
) g + (1 * g) + (1 * Ratio Payout * EPS
+
g - r
r) + (1
g) + (1
1 * g) + (1 * Ratio Payout * EPS
= P
|
|
.
|

\
|



n
n
n
n
n
n
n
0
0
r) + )(1 g - (r
) g + (1 * g) + (1 * Ratio Payout
+
g - r
r) + (1
g) + (1
1 * g) + (1 * Ratio Payout
=
EPS
P
|
|
.
|

\
|



PEG = PE / Expected Growth Rate in Earnings


n
n
n
n
n
n
n
r) + )(1 g - g(r
) g + (1 * g) + (1 * Ratio Payout
+
g) - g(r
r) + (1
g) + (1
1 * g) + (1 * Ratio Payout
= PEG
|
|
.
|

\
|



Relative PE =PE of Firm / PE of Market


EV/FCFF =
n
WACC) + )(1
n
g - (WACC
)
n
g + (1
n
g) + (1
0
FCFF
+
g - WACC
n
WACC) + (1
n
g) + (1
- 1 g) + (1
0
FCFF
=
0
V
|
|
.
|

\
|
(Market Value of Equity +Market Value of Debt-Cash)
EBIT (1-t) - (Cap Ex - Deprecn) - Chg in Working Cap




Page 12 of 14
n
n
n
n n
n
0
0
WACC) + )(1 g - (WACC
) g + (1 g) + (1
+
g - WACC
WACC) + (1
g) + (1
- 1 g) + (1
=
FCFF
V
|
|
.
|

\
|


on Depreciati and Taxes Interest, before Earnings
Debt of Value Market + Equity of Value Market
EBITDA
Value
=

on Depreciati and Taxes Interest, before Earnings
Cash - Debt of Value Market + Equity of Value Market
EBITDA
Value Enterprise
=

g - WACC
FCFF
= V
1
0


g - WACC
Capital Working - Cex - (t) Depr + t) - (1 EBITDA
= Value



g - WACC
ITDA Capital/EB Working
-
g - WACC
CEx/EBITDA
-
g - WACC
(t)/EBITDA Depr
+
g - WACC
t) - (1
=
EBITDA
Value


Price/Book Value = Market Value of Equity / Book Value of Equity

n
1
0
g r
DPS
P

=
n
n 0
0
-g r
) g (1 * Ratio Payout * ROE * BV
P
+
=

n
n
0
0
-g r
) g (1 * Ratio Payout * ROE
= PBV
BV
P +
=

n
0
0
-g r
Ratio Payout * ROE
= PBV
BV
P
=

n
n
0
0
-g r
g - ROE
= PBV
BV
P
=

n
n
n
n
n 0
n
n
0
0
r) + )(1 g - (r
) g + (1 * g) + (1 * Ratio Payout * EPS
+
g - r
r) + (1
g) + (1
1 * g) + (1 * Ratio Payout * EPS
= P
|
|
.
|

\
|



(
(
(
(

|
|
.
|

\
|

n
n
n
n
n n
n
n
0
0
r) + )(1 g - (r
) g + (1 * g) + (1 * Ratio Payout * ROE
+
g - r
r) + (1
g) + (1
1 * g) + (1 * Ratio Payout * ROE
=
BV
P

Page 13 of 14


g - WACC
/BV FCFF
=
BV
V
1 0


Value/Book Value =
Book Value of Equity +Book Value of Debt

Price/ Sales=
Market Value of Equity +Market Value of Debt
n
n
0
0
-g r
) g (1 * Ratio Payout * Margin Profit Net
= PS
Sales
P +
=
Market Value of Equity
Total Revenues



n
n
n
n
n 0
n
n
0
0
r) + )(1 g - (r
) g + (1 * g) + (1 * Ratio Payout * EPS
+
g - r
r) + (1
g) + (1
1 * g) + (1 * Ratio Payout * EPS
= P
|
|
.
|

\
|



(
(
(
(

|
|
.
|

\
|

n
n
n
n
n n
n
n
0
0
r) + )(1 g - (r
) g + (1 * g) + (1 * Ratio Payout * Margin Net
+
g - r
r) + (1
g) + (1
1 * g) + (1 * Ratio Payout * Margin Net
=
Sales
P


Value/ Sales=
(
(
(
(

|
|
.
|

\
|

n
n
n
n
stable
n
n
growth
0
WACC) + )(1 g - (WACC
) g + (1 * g) + )(1 RIR - (1
+
g - WACC
WACC) + (1
g) + (1
1 * g) + )(1 RIR - (1
* Margin Oper. tax - After =
Sales
Value
Market Value of Equity +Market Value of Debt-Cash
Total Revenues






+
N = t
1 = t
r) + (1
Value Terminal
t
r) + (1
t
CF
= Value
N

= t
1 = t
t
r) + (1
t
CF
= Value

n = t
1 = t
t
e
t
) k + (1
Equity to CF
= Equity of Value

n = t
1 = t
t
t
WACC) + (1
Firm to CF
= Firm of Value
Page 14 of 14
Normal Distribution Table


Normal Distribution
d N(d) d N(d) d N(d)
-3.00 0.0013 -1.00 0.1587 1.05 0.8531
-2.95 0.0016 -0.95 0.1711 1.10 0.8643
-2.90 0.0019 -0.90 0.1841 1.15 0.8749
-2.85 0.0022 -0.85 0.1977 1.20 0.8849
-2.80 0.0026 -0.80 0.2119 1.25 0.8944
-2.75 0.0030 -0.75 0.2266 1.30 0.9032
-2.70 0.0035 -0.70 0.2420 1.35 0.9115
-2.65 0.0040 -0.65 0.2578 1.40 0.9192
-2.60 0.0047 -0.60 0.2743 1.45 0.9265
-2.55 0.0054 -0.55 0.2912 1.50 0.9332
-2.50 0.0062 -0.50 0.3085 1.55 0.9394
-2.45 0.0071 -0.45 0.3264 1.60 0.9452
-2.40 0.0082 -0.40 0.3446 1.65 0.9505
-2.35 0.0094 -0.35 0.3632 1.70 0.9554
-2.30 0.0107 -0.30 0.3821 1.75 0.9599
-2.25 0.0122 -0.25 0.4013 1.80 0.9641
-2.20 0.0139 -0.20 0.4207 1.85 0.9678
-2.15 0.0158 -0.15 0.4404 1.90 0.9713
-2.10 0.0179 -0.10 0.4602 1.95 0.9744
-2.05 0.0202 -0.05 0.4801 2.00 0.9772
-2.00 0.0228 0.00 0.5000 2.05 0.9798
-1.95 0.0256 0.05 0.5199 2.10 0.9821
-1.90 0.0287 0.10 0.5398 2.15 0.9842
-1.85 0.0322 0.15 0.5596 2.20 0.9861
-1.80 0.0359 0.20 0.5793 2.25 0.9878
-1.75 0.0401 0.25 0.5987 2.30 0.9893
-1.70 0.0446 0.30 0.6179 2.35 0.9906
-1.65 0.0495 0.35 0.6368 2.40 0.9918
-1.60 0.0548 0.40 0.6554 2.45 0.9929
-1.55 0.0606 0.45 0.6736 2.50 0.9938
-1.50 0.0668 0.50 0.6915 2.55 0.9946
-1.45 0.0735 0.55 0.7088 2.60 0.9953
-1.40 0.0808 0.60 0.7257 2.65 0.9960
-1.35 0.0885 0.65 0.7422 2.70 0.9965
-1.30 0.0968 0.70 0.7580 2.75 0.9970
-1.25 0.1056 0.75 0.7734 2.80 0.9974
-1.20 0.1151 0.80 0.7881 2.85 0.9978
-1.15 0.1251 0.85 0.8023 2.90 0.9981
-1.10 0.1357 0.90 0.8159 2.95 0.9984
-1.05 0.1469 0.95 0.8289 3.00 0.9987
-1.00 0.1587 1.00 0.8413