Corporate Valuation

Assignment – 1

Group – 2
Mohit Garg PGP/23/031
Sashank Sharma PGP/23/039
Harsha Jain PGP/23/142
Rituraj Paul PGP/23/187
Chapter 8
3)
a. Cost of Equity (Ke) = Rf + Beta*(Risk Premium)
Ke = 6.4% + 1.7*(5.5)
Ke = 15.75%

b. Cost of Equity (Ke) with long term bond rate of 7.5% is,
Ke = 7.5% + 1.7*(5.5)
Ke = 16.85%
The cost of equity increased by 1.1 percentage points.

c. The entire risk can be categorized as a business risk for the company as it
has no debt, wherein the financial risk of the company is nil.

6)
Debt of Safecorp = $50 million
Equity of Safecorp = $100 million
Debt-Equity Ratio after LBO = 8
So, the new debt raised for the LBO is = (50+x)/100 = 8
New debt raised = 750 million

Calculation of Unlevered Beta Before the LBO,

Levered beta = Bu[1 + (1-t)D/E]
1.2 = Bu[1+(1-0.4)1/2]
1.2 = Bu*(1.3)
Bu = 0.923
Calculation of Leveraged beta after LBO,
Levered Beta = 0.923 *[1+0.6*(8)]
Levered Beta = 0.923*(5.8)
Levered Beta = 5.3534
Beta of equity in the firm after the LBO is 5.3534.

7)
a. New Beta after merger = (2/3)*1.5 + (1/3)*1.3
New Beta after merger = 1 + 0.433 = 1.433

b. Levered Beta = 1.5 + 1.5*0.6*0.5

Levered Beta = 1.5 + 0.45
New Beta after merger through debt = 1.95

13)
Given,
Intercept = 0.06
Slope = 0.46
Standard Error = 0.2
R-Squared = 5%.

A)
We know, slope of regression equals beta.
Risk free rate = 6%
Expected return = 6 + 0.46 * (Market Risk Premium)
Taking a market risk premium of 5.5%
Expected Return = 6 + 0.46*5.5 = 8.53%
B)
R-square equals 5%
Proportion of the firm’s risk which is diversifiable = (1-0.05) = 95%
C)
Total value of Mapco before divesting
= 20 + 20*2 = 60 million
Debt = 20 million
Equity = 40 million
Beta estimated = 0.46
Tax Rate = 0.36
Beta unlevered before divesting = (0.46)/[1+(1-0.36)(20/40)] = 0.35
Beta of the firm that was divested = 0.2
Beta Rem = ??
Value of firm to be divested = 20 million
Value of firm remaining = (60-20) = 40 million
0.35 = 0.2*(20/60) + Beta Rem (40/60)
Beta Rem = 0.425
After new acquisition, value of the firm = (60-20+50) = 90
New unlevered beta for the firm after acquisition
= 0.425 * (40/90) + 0.8 * (50/90) = 0.633

18)
A)
Given,
Beta for Chrysler = 1.05
Debt = $13 billion
Equity = (355*50) =$17.75 billion
Tax Rate = 36%
Beta unlevered (including cash) = 1.05/(1+(1-.36)(13/17.75)) = 0.715
Cash = $8billion
Non-cash component = (13+17.75-8) = 22.75
BetaNon-cash = ??
0.715 = BetaNon-cash*(22.75/30.75) + Betacash*(8/30.75)
Betacash = 0
Thus, BetaNon-cash = (0.715*30.75/22.75) = 0.966
B)
After paying out $5 billion dividend, firm value = 30.75-5=$25.75 billion
Cash component = 8-3 = $5billion
New Beta unlevered for the firm = 0.966*(22.75/25.75) + 0*(3/25.75) = 0.853
C)
After dividend pay-out, equity for the firm = 17.75-5 = $12.75 billion
Beta for Chrysler = 0.853*(1+(1-0.36)(13/12.75)) = 1.41
20)
A)
Comparable beta of publicly traded firms = 0.95
Average D/E ratio = 35%
Tax rate = 36%
Unlevered beta for comparable firms = 0.95/(1+(1-0.36)(0.35)) = 0.7761
Beta for the division = 0.7761*(1+(1-0.36)(0.25)) = 0.90
B)
If RJR Nabisco had a much higher fixed cost structure than other comparable
firms, it would have high operating leverage. This will lead to a higher value of
unlevered beta for the firm as compared to other comparable firms.

Chapter 10
1)
Ke = 5.5%
Tax = $12.5 million
Reinvestment = $15 million
Cost of Capital = 11%
Marginal Tax Rate = 35%
Growth in the next 3 years = 10%
Growth perpetuity = 5%

a. Effective Tax Rate = 12.5 x 100% /50 = 25%

1 2 3 Terminal Year
EBIT $ 50 $ 55.0 $ 60.5 $ 66.55
EBIT(1-t) $ 37.50 $ 41.25 $ 45.38 $ 49.91
Reinvestment $ 15.00 $ 16.50 $ 18.15 $ 19.97
FCFF $ 24.75 $ 27.23 $ 29.95
Terminal Value $ 524.08
Present Value $ 22.30 $ 22.10 $ 405.10
Firm Value $ 449.49
 b.
1 2 3 Terminal Year
EBIT $
$ 50 $ 55.0 $ 60.5 66.6 $ 69.88
EBIT(1-t) $ 32.50 $ 35.75 $ 39.33 $ 43.26 $ 45.42
Reinvestment $ 15.00 $ 16.50 $ 18.15 $ 19.97 $ 20.96
FCFF $ 19.25 $ 21.18 $ 23.29 $ 24.46
Terminal Value $ 407.62
Present Value $ 17.34 $ 17.19 $ 315.08
Firm Value $ 349.61

c.
1 2 3 Terminal Year
EBIT $
$ 50 $ 55.0 $ 60.5 66.6 $ 69.88
EBIT(1-t) $ 37.50 $ 41.25 $ 45.38 $ 49.91 $ 45.42
Reinvestment $ 15.00 $ 16.50 $ 18.15 $ 19.97 $ 20.96
FCFF $ 24.75 $ 27.23 $ 29.95 $ 24.46
Terminal Value $ 407.62
Present Value $ 22.30 $ 22.10 $ 319.94
Firm Value $ 364.34

4)
Revenue = $1,54,951
COGS = $ 1,03,871
Assets Liabilities
Cash $ 19,927.00 Accounts Payable $ 11,635.00
Receivables $ 1,32,904.00 Debt due within 1 year $ 36,240.00
Inventory $ 10,128.00 Other Current Liabilities $ 2,721.00
Current Assets $ 91,524.00 Current Liabilities $ 50,596.00
Fixed Assets $ 45,586.00 Short Term Debt $ 36,200.00
Long Term Debt $ 37,490.00
Equity $ 12,824.00
Total Assets $ 1,37,110.00 Total Liabilities $1,37,110.00

a) Net Working Capital = Current Assets – Current Liabilities

= $ 91,524 - $ 50,596
= $ 40,928

b) Non-Cash Current Assets = Current Assets – Cash

 = $ 91,524 - $ 19,927
= $ 71,597
Non-Cash Current Liabilities = Current Liabilities – Debt due within 1 yr
= $ 50,596 - $ 36,240
= $ 14,356
Non-Cash Working Capital = $ 71,597 - $ 14,356
= $ 57,241

c) Non-Cash Working Capital = $ 57,241/ $ 1,54,951 = 36.94%

as a % of Revenues
5)
a)

(in $) 1 2 3 4 5
1,54,951. 1,8 2,49,550.1
Revenues 00 1,70,446.10 7,490.71 2,06,239.78 2,26,863.76 4
Non-Cash Working
Capital as a % of
Revenues 36.94% 36.94% 36.94% 36.94% 36.94% 36.94%
Non-Cash Working 57,2 $62,965.1 6
Capital 41 0 9,261.61 76,187.77 83,806.55 92,187.20
Expected Changes
in Non-Cash 5,724
Working Capital .10 6,296.51 6,926.16 7,618.78 8,380.65

b)

(in $) 1 2 3 4 5
1,54,951. 1,87,
Revenues 00 1,70,446.10 490.71 2,06,239.78 2,26,863.76 2,49,550.14
Non-Cash
Working Capital
as a % of
Revenues 4.30% 4.30% 4.30% 4.30% 4.30% 4.30%
Non-Cash 6,66 7,329.1
Working Capital 2.89 8 8,062.10 8,868.31 9,755.14 10,730.66
Expected Changes
in Non-Cash 732.
Working Capital 666.29 92 806.21 886.83 975.51

6)
a. Revenue t = $1000 million
Revenue t+1 = $1100 million
EBIT (1-t) = $ 80 million
Working capital = 50/1000 = 5%
 Change in working capital = 5% * $(1100-1000) = -$5 million

FCFF = EBIT (1-t) - change in working capital

= 80 – (-5) = $85 million
b. I believe that if we have to forecast cashflows for the next 10 years, it is
better to look into the historical working capital values of the firm or use
the industry average working capital or keep a fixed percentage of
revenue. The reason is that it is possible that in the long term we can
have a negative working capital, or such situations can arise wherein the
working capital becomes a use of cash instead of continue being a source
of cash.

Chapter 11
3)
Net Income = $150 million
BV of equity = $1000 million
Capital expenditure = $160 million
Depreciation = $ 100 million
Increase in Working capital = $40 million
Increase in Debt = $40 million
Equity reinvested in business = Capital expenditures − Depreciation + Change
in working capital − (New debt issued − Debt repaid)
= $160-100+40-40 = $60 million
Equity reinvestment rate = Equity reinvested/Net income
= $(60/150) *100 = 40%
Return on Equity = Net Income/ BV of equity
= $150/1000 = 15%
Expected growth in net income = Equity reinvestment rate × Return on
equity
= 40% * 15%
= 6%
4)
Net Income = $100 million
Capital Invested = $800 million
Capital expenditure = $25 million
Increase in Working capital = $15 million

a. Return on Equity = Net Income/ BV of equity

= $100/800 = 12.5%

Equity reinvested in business = Capital expenditures − Depreciation + Change

in working capital − (New debt issued − Debt repaid)
= $25+15 = $40 million
Equity reinvestment rate = Equity reinvested/Net income
= $(40/100) *100 = 40%
Expected growth in net income = Equity reinvestment rate × Return on
equity
= 40% * 12.5%
= 5%
b. Return on Capital (ROCt) = 12.5% + 2.5% = 15%

Expected growth rate = ROCt × Reinvestment rate + (ROCt –

ROCt−1)/ROCt
= 15% * 40% + (15%-12.5%)/12.5%
= 26%

Excel Sheet
Detailed workings for required questions have been represented using an excel
sheet. Please find herewith enclosed the link for the same.

Assignment%201.xls
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