1. Prepare to explain the implications of case Exhibit 1 (Paige Simon’s first task). Based on that exhibit, is terminal value (TV) a material component of firm values? From the exhibit, we can find the PV of five years’ dividends is small part of the market price of the stock. In my opinion, we buy a stock then get dividend periodically, which like buy a bond. The coupon payment is dividend and the face value is terminal value. The bond value is determined by the terminal value mostly. So the stock price is also determined by terminal value. The concept of going concern can explain that Terminal value is often higher than the present value of near term cash flows, which means that a company's long-term cash-flow capacity is more important. 2. Drawing on case Exhibit 4 and your own general knowledge, where would the various estimators be appropriate? Where would they be inappropriate? (Simon’s second task) |Approach |appropriate |inappropriate | |Book value |Depreciation (accounting) |When the book value is quite different from fair | | | |value | |Liquidation value |Bankrupt company (capital budgeting, cases like |Liquidation value will inappropriate for a company | | |machines, plants, natural resources projects, which |which is doing well, because it ignores “going | | |have definite lives) |concern” value. | | |firms in weird market conditions | | |Replacement Value |Fixed asset (like PP&E) |...

...APV approach would be more suitable to valuate the cashflows between 2008 and 2012.
After 2012, AirThread will de-lever to industry norm and thus, they will have a target leverage ratio; therefore WACC is best to estimate the terminalvalue.
Finally, regarding the valuation of non-operating investments in equity affiliates, due to limited data, market multiple approach would be better to use.
2 – Valuation of AirThread
Regarding the estimation of the long-term growth rate, Ms. Zhang knows that the long-term growth rate would be a function of the company’s return on capital (ROC) and reinvestment rate. According to the definition given in the case, ROC is defined as net operating profits after taxes divided by the book value of equity and debt. Since, there is not enough data on book value of the comparable firms; we can use the market value of equity and debt for estimation. AirThread’s ROC should be in line with its peers at 3.0%, calculated below :
Equity Mrkt Debt/ Debt Net
Comparable Companies: Value Equity Value Income ROC
Universal Mobile 65,173 92.3% 60,160 3,794 0.030
Neuberger Wireless 94,735 41.4% 39,261 4,103 0.031
Agile Connections 37,942 24.1% 9,144 (30) (0.001)
Big Country Communications 47,314 31.7% 15,003 3,384 0.054
Rocky Mountain Wireless 5,299 44.4% 2,353 240 0.031
Avrge ROC 3%...

...Article 1discusses how different estimates of equity value are obtained by researchers while using the discounted cashflow model (CF) and the Residual income (RI) model. It recognises the inconsistencies prevalent while implementing them. Francis et al (2000) use Value line estimates for finite forecasting periods. They conclude that RI is superior to CF. Courteau et al (2000) analyse whether different valuation models are same when a terminalvalue calculation based on price is used. They conclude that RI is dominant to CF when terminal price forecasts are not obtainable. Penman and Sougiannis (1998) examine the differences in model estimates by using a portfolio of ex post realizations of financial statement data. They conclude that methods based on projecting GAAP accrual earnings give lower valuation errors than forecasting cashflows.
The inconsistent forecasts error occurs when there is an error in the starting value of the terminalvalue perpetuity. In order to prevent this error, a financial statement forecast in the terminal period using the terminal growth rate has to be developed and the relevant valuation attribute in the year T + 1 should be constructed. This error is experienced in all three papers. The inconsistent discount rate error arises due to inconsistency...

...Calculate the TerminalValue
Having estimated the free cashflow produced over the forecast period, we need to come up with a reasonable idea of the value of the company's cashflows after that period - when the company has settled into middle-age and maturity. Remember, if we didn't include the value of long-term future cashflows, we would have to assume that the company stopped operating at the end of the five-year projection period.
The trouble is that it gets more difficult to forecast cashflows over time. It's hard enough to forecast cashflows over just five years, never mind over the entire future life of a company. To make the task a little easier, we use a "terminalvalue" approach that involves making some assumptions about long-term cashflow growth.
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Gordon Growth Model
There are several ways to estimate a terminalvalue of cashflows, but one well-worn method is to value the company as a perpetuity using the Gordon Growth Model. The model uses this formula:
TerminalValue = Final Projected Year Cash...

...potential to grow, which makes an acquisition easy to finance. 3) Interco is also a cash generative target for a potential acquirer as it generates approximately $0.10 of operating cashflow for every dollar of sales. 4) The company is also structured in a way that it could be broken up and sold into its constituent parts, which could prove to be worth more than the whole.
2. As a member of the Board of Interco, neither the Premiums Paid Analysis nor the Comparable Transaction Analysis is very convincing.
Premiums Paid Analysis – At first glance, the premiums paid analysis indicates that the Rales Proposal undervalues the stock relative to other recent transactions. However, this measure has limited reliability in that it is not directly related to the company’s financial outlook. Additionally, this analysis does not indicate which industries are being used as comps, so it is impossible to tell how relevant this data really is.
Comparable Transaction Analysis – Since Interco is a conglomerate, no one industry segment will provide an accurate measure of the effectiveness of the Rales Proposal in the aggregate. Also none of the comps are even close in size to the aggregate valuation range of the Rales Proposal. Therefore, thee comps may not be relevant as smaller companies may have different growth and profitability dynamics.
3. See Discounted CashFlow Analysis #1 for a discounted...

...strongly encouraged to use spreadsheets. Refer to Note on Sample CashFlow Template.
Question 1
(5 points) The project with the highest IRR is always the project with the highest NPV.
Your Answer | | Score | Explanation |
True | | | |
False | ✔ | 5.00 | Correct. Try now to sort this out in different contexts, |
Total | | 5.00 / 5.00 | |
Question Explanation
This is all about the fundamental difference between IRR and NPV.
Question 2
(10 points) Ann Arbor is considering offering public bus service for free. Setting up the service will cost the city $0.6M (where M stands for million). The useful life of the buses is 25 years. Annual maintenance of the buses would cost $50,000 per year and they would need a major overhaul in year 15 that will cost a total of $350,000. This overhaul is in addition to the annual maintenance. Annual operating costs will begin at $90,000 in year 1 and grow at 2% per year thereafter. By using the buses as advertisement space, the city will generate a revenue of $75,000 in year 1 and it will grow at 4% per year thereafter. Reduced parking requirements and other benefits generated by the project will save the city $100,000/year. The salvage value (price city can get in the future after maintenance) of the used buses in year 25 is expected to be $150,000. What is the NPV of the bus proposal? Ann Arbor does not pay taxes and the discount rate is 5%.(Again, all cash...

...(qualitatively) to value AirThread. Should Ms. Zhang use WACC, APV or some combination thereof? Explain. (2 points)
* From the statement of AirThread case, we know that American Cable Communication want to raise capital by Leveraged Buyout (LBO) approach. This means ACC will finance money though equity and debt to buy AirThread and pay the debt by the cashflows or assets of AirThread.
* In another word, it’s a highly levered transaction using a fixed WACC discount rate; however the leverage is changing in fact.
* If we want to use WACC method, one assumption must be met: this program will not change the debt-equity ratio of AirThread. Under LBO approach, it’s impossible.
* So we decide to use APV method to value AirThread. WACC method is not appropriate here, but we still need to calculate the weight average cost of capital (WACC) of AirThread.
Approach to value AirThread before considering any synergy
1. Develop a projection of unlevered free cashflow for AirThread.
* Discount AirThread’s unlevered free cashflows at unlevered WACC.
2. Determine the PV of interest tax shield:
* Discount AirThread’s interest tax shield by debt cost of capital (interest rate of debt).
3. Add the unlevered value to the PV of interest tax shield to get the value of the acquisition.
4. Using Dividend...

...Exam 2 Part 2
Answer any EIGHT of the ten questions. Each question is worth 5 points.
Return your answers to me by 11:59 PM Sunday 11 November 2012
1. A number of publicly traded firms pay no dividends yet investors are willing to buy shares in these firms. How is this possible? Does this violate our basic principle of stock valuation? Explain.
Our basic principle of stock valuation is that the value of a share of stock is simply equal to the presentvalue of all of the expected dividends on the stock. According to the dividend growth model, an asset that has no expected cashflows has a value of zero, so if investors are willing to purchase shares of stock in firms that pay no dividends, they evidently expect that the firms will begin paying dividends at some point in the future.
2. Explain why some bond investors are subject to liquidity risk, default risk, and/or taxability risk. How does each of these risks affect the yield of a bond?
Liquidity problems exist in thinly traded bonds making some bonds difficult to sell at their actual value. Default risk is the likelihood the corporation will default on its bond obligations. Taxability risk reflects the fact that some bonds are taxed disadvantageously compared to others. If any of these risks exist, investors will require compensation by demanding a high yield.
3. The discussion of asset pricing in the text suggests...

...| 2010 |
| Team “TerminalValue” [Kohler - BuSINESS DECISION] |
FIN 553 Spring Term 2010 |
Executive Summary
Both approaches (used to come up with the value of the Kohler Company) are greatly impacted by the assumptions made by both the company and the dissenting shareholders.
The use of the Market approach has shown that the value of the company varies greatly depending on the comparable companies. If Masco (which is the largest comparable company) is included, the value goes to nearly $3.7 B and excluding it causes the value to go down to $1.2 B. Moreover, depending of the discount for lack of liquidity and control, the value of the company could decrease considerably. Then, in the market approach there are two variables that affect the value of the company; comparable peers and the discount for lack of liquidity and control.
In the Free CashFlow (FCF) approach, the two variables that makes the value diverge is the Beta and the discount (liquidity and control) used. In this specific scenario the Beta impacts the WACC considerably due to the high weight of the cost of equity. For example, a difference of 4 points in the WACC raises the value of the company more than 150% [Table 7].
It is interesting to see that in order to arrive at Kohler’s initial valuation of $58K per share; a 65%...