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Investments HW 5

This homework should reflect your own work. Please use Excel to perform the tasks. It is recommended you create an Excel worksheet for each of the problem questions. Please mark your answers clearly. For questions that doesn’t involve calculations, please type in your answers in the same Excel file as texts and clearly label your answers so it is easy for the TAs to locate them.

1. (20 points) Radius Manufacturing started operations on December 31, 2019, acquiring a new facility for a total of $500 million. Below are financial statements for 2019 and 2020 in millions of dollars.  What is Radius’ Free Cash Flow in 2020?

NOTE: Assume that Net Working Capital = Accounts Receivable + Inventory – Accounts Payable.

Questions 2:

XYZ Corporation does not currently pay cash dividends and is not expected to for the next five years. Its latest EPS was $10, all of which was reinvested in the company. The firm’s expected ROE for the next five years is 20% per year, and during this time it is expected to continue to reinvest all of its earnings. Starting in year 6, the firm’s ROE on new investments is expected to fall to 15%, and the company is expected to start paying out 40% of its earnings in cash dividends, which it will continue to do forever after. XYZ’s market capitalization rate is 15% per year. Please answer the following questions:

1) (15 points) Project the earnings and dividends for each ear from year 0 to year 6 (assuming the dividend will grow at the same rate as ROE)

2) (15 points) Estimate XYZ’s intrinsic value per share, using a two-stage DDM model

Questions 3:

You are trying to value a private firm, Acme Inc., to figure out how much money it can expect to raise in an IPO.  Acme Inc. manufactures pool equipment.  In the current year, Acme has sales of $1M and the free cash flow of $0.5M.

You identified two publicly traded firms, Firm A and Firm B, with very similar business models, on which you will base your valuation.

You looked up the following information, for the current year, for these comparable firms:

1) (10 points) What is Acme’s valuation as measured by the sales multiple of comparable firms?

2) (10 points) What is Acme’s valuation as measured by the cash flow multiple of comparable firms?

3) (30 points) You expect that Acme’s sales and cash flows will grow in perpetuity at the annual growth rate of 3%.   Furthermore, you observe that the risk-free rate is 2%.  You estimate that the expected market risk premium is 5%.  Assume that the beta of debt is 0.25 for all firms.  What is the Discounted Cash Flow valuation of Acme? (HINT: Use the Gordon Growth Formula. For discount rates for ACME, use the CAMP model with ACME beta being the average asset beta of firm A and B, which can be calculated as

i. Beta(asset) = E/(D+E) *beta_equity + D/(D+E) *beta_debt,

where D and E are debt and equity value)