IB3960 Financial Statement Analysis and Security Valuation Exam Paper Summer 2021

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Question 1

You recently graduated from Warwick Business School and joined UBA as a sell-side analyst. Your first assignment is to value Exco Plc. After working on the information available for Exco Plc, you produced the following summary forecasts for Exco Plc for the next three years (all figures in £ million):

The analyst expects net operating assets to grow at 5% per annum after 2023 (i.e., net operating assets at the beginning of 2024 are expected to be £2520 million and so on) and asset turnover and operating profit margin after tax to remain at their 2023 level in all following years. Assume that the company has a weighted average cost of capital of 10% for all future years.

Your head of equity research is not very impressed with your summary forecasts. She needs more detailed forecasts.

She asked you to write an internal report to show the following, in addition to the summary forecasts above.

a)   Operating profit margin after tax, asset turnover (using net operating assets at beginning of year), return on net operating assets, abnormal operating profit and free cash flow for 2021, 2022, and 2023.   [15 marks]

b)  Estimation of the economic value of Exco Plc’s operating activities at the beginning of 2021 using free cash flow model.   [15 marks]

c)  Brief explanation of why a firm have negative free cash flow.      [10 marks]

d)  Brief explanation of how to apply reverse engineering process to understand market implied growth rate.  [10 marks]

e)  Discussion of why a firm should have high P/E and P/B and the role of return on equity in explaining these two multiples.  [25 marks]

f)   A summary of your role as a sell-side analyst in the capital market.   [25 marks] (Total: 100 Marks)