Corporate Finance

Corporate Finance
Exercises session #1
Blocks 1 to 6
October 9th, 2018
Corporate Finance: Lectures and Seminars, HEC Liège (ULiège) 2017-2018 – Marie Lambert 1
Fundamentals – Q1
Assume you want to save money to buy a car three years
from now (end-of-month) for a price of $18,000. You decide
to put $500 at the end of each month on a bank account with
a nominal interest rate of 1.00%, compounded annually.
a) Will you be able to buy the car in three years?
b) Imagine you prefer to invest one single amount now
instead of saving money each month. Given the same
interest rate, what amount should you put on the bank
account?
Fundamentals – Q2
You are looking to invest in a limited edition luxury watch
(retail price of $8,000) that you know for sure the price on
the secondary market will be $10,000 ten years from now.
You assume the luxury watch secondary market has the same
risk as the zero-coupon bonds’ European market. Based on
the euro area yield curve, these bonds have an average 10-
year yield of 1.25%.
Should you invest in the luxury watch? Use the « tracking
portfolio » approach to justify your choice. Intuitively, do you
think your assumption about risk make sense?
Financial Analysis – Q1
You estimate that a180company’s sales will increase from (in
millions) $170 to $185 by the end of this year. Your vertical
analysis shows that COGS can be approximated to 60% of
sales each year. In addition, elements of the Working Capital
can be computed as follows:
• Accounts receivable = 8% of sales;
• Accounts payable = 20% of COGS;
• Inventory = 9% of COGS.
What is the expected investment in WC by the end of the
year? Is it a cash inflow or outflow?
You are provided with the following financial information about a
company:
SUMMARY BALANCE SHEET

(in millions)
N-2 N-1 N
SUMMARY INCOME STATEMENT
Total cash & ST investments 8,481 8,194 8,527
(in millions)
Total receivables 10,765 9,533 10,249
N-2 N-1 N
Inventory 2,103 1,551 1,553
Total revenues 92,793 81,741 79,919
Other current assets 24,797 23,225 23,570
Cost of goods sold 46,386 41,057 41,624
Total current assets 47,377 42,504 43,889
Gross profit 46,407 40,684 38,295
Property, plant & equipment 10,771 10,727 10,830
Selling general & admin exp. 21,549 19,589 19,977
Long-term investments 1,222 1,131 659
R & D exp. 5,437 5,247 5,751
Other long-term assets 57,901 56,133 62,092
Other operating expenses 708 669 1,604
Total assets 117,271 110,495 117,470
Operating income 20,129 16,517 14,171
Accounts payable 6,864 6,028 6,209
Income tax expense 4,234 2,581 449
Other current liabilities 28,116 22,970 23,826
Net income 12,022 13,190 11,872
Total current liabilities 39,581 34,269 36,275
Long-term debt 34,991 33,431 34,663
Total liabilities 105,257 96,071 99,078
a) Compute the accounts receivable turnover for each year. How has
the situation evolved from N-1 to N?
b) Compute the inventory turnover for each year. How has the
situation evolved from N-1 to N?
c) You know that DPO went from 57.31 in N-1 to 53.65 in N. How has the
situation evolved? Compute and interpret accounts payable
turnover’s evolution accordingly.
d) Based on the above calculations, compute and interpret the evolution

of the DSO and DIO from N-1 to N.
e) Finally, compute and interpret the evolution of the CCC from N-1 to N.
Please consider that one year = 365 days. If you have to make a choice
between end-of-year and average B/S values, select the average convention.
You are provided with the following financial information about a
company (tax rate = 20%):
Year N Year N Year N+1
Fixed assets 181,777 123,549 Equity Revenue 170,910 198,500
Accounts receivable 20,641 Gross profit 64,304 70,537
83,451 Debt
Inventory 7,650 EBITDA 53,474 58,544
Cash 40,590 43,658 A/P EBIT 48,999 52,503
Total 250,658 250,658 Total Net income 37,037 39,510
Year N+1
Fixed assets 236,910 111,547 Equity
Accounts receivable 27,219
120,292 Debt
Inventory 6,000
Cash 25,158 63,448 A/P
Total 295,287 295,287 Total
a) Comment the evolution of the company’s ROE. What can explain this
evolution? (hint: use the DuPont short form decomposition).
b) Compute the ROA using two approaches and interpret the ratios.
FCFF – Q1
As a financial analyst of a computer manufacturer, you have been asked by
the CFO to estimate the expected Free Cash Flows to the Firm (FCFF) of a
new notebook, the “AugurBook". In this context, you have gathered the
following information:
– The notebook market has a total revenue of $200,000 million as of
year 0, with an expected growth rate of 10% next year.
– The market share of the AugurBook is estimated to 0.5% the first
commercialization year (one year from now). AugurBook’s
revenues will then grow by 15% during one year. Growth rate will
be assumed constant at 5% afterwards.
– AugurBook's incremental COGS will be 20% of annual revenues,
and other cash operating expenses will amount to 10%.
FCFF – Q1
– For the production of the AugurBook, the company will have to
invest $1,500 million in year 0.
– The investment will be depreciated over 5 years using a straight-
line depreciation method.
– Company's marginal tax rate is 35%, but its effective tax rate is
25%.
What are the project's Free Cash Flows to the Firm (FCFF) from now to
year 3?
FCFF – Q2
As part of XYZ's valuation, you have been requested to forecast Free Cash Flows to
the Firm from N+1 to N+5. As such, you have to estimate capital expenditures
(CAPEX) and depreciations. You know that:
– In December N, fixed assets amounted to $1.5 million and revenues to $2
million.
– Next year, the company is going to buy a new machinery for $300,000.
Installation costs are expected to be $10,000. For other years, new fixed
assets investments represent each year, on average, 10% of annual (end-
of-year) revenues.
– In order to keep assets working properly, maintenance investments must
be expensed at the beginning of each year, for an amount that equals 1% of
beginning-of-year fixed assets.
What are the expected depreciations and end-of-year assets values in N+1 and
N+2? Consider a 5% steady growth rate for revenues and a 10-year straight-line
depreciation method (to simplify, depreciation is assumed to be 10% of the
beginning-of-year fixed assets).
WACC – Q1
(August 2018 exam)
You want to value EVO Ltd., a listed company active in the advertising
industry, by discounting the Free Cash Flows to the Firm (FCFFs). EVO’s
corporate bonds were rated BBB at the time they were issued, with a
Yield-To-Maturity (YTM) of 9%. As of today, BBB bonds trade at 4%. EVO
is currently rated BB+, and BB+ rated bonds trade at a spread of 0.5%
over BBB bonds.
• Risk-free rate = 1.5%.
• Leverage (as measured by D/E) = 0.6.
• Unlevered beta = 0.95.
• Tax rate = 30%.
• Expected return on the market = 6.5%.
Based on the following information, which discount rate would you use in
your DCF?
WACC – Q2
You are trying to determine the value of eView Corporation, a private tech
company, using the Discounted Cash Flow (DCF) model based on cash
available to both providers of capital (debt and equity holders).
You have gathered the following information about eView:
– Capital structure: long term debt’s market value is $100 million,
with annual interest payments of 5% and a Yield-To-Maturity
(YTM) of 3.5%; shareholder equity is $55 million.
– Beta: as eView is not listed, you have collected the following data
about eView’s comparable listed companies:
Listed
Beta D/E Tax rate
comparable
Prism 1.1 1.5 35%
Yota 1.3 2.3 35%
xOS 0.9 1.0 35%
WACC – Q2
– Cost of equity: risk free rate is 2%, expected market return is 6%.
– eView’s tax rate is 35%.
What is your estimate of the rate you should use to discount eView’s Free
Cash Flows to the Firm?
Firm valuation – Q1
A firm is expected to generate net cash flows of $2,000 for each of the next
five years (phase 1). After five years (i.e. starting on year 6) (phase 2), the
firm’s cash flows are expected to grow at a constant rate of 2.5%. The
owners of the firm would like to be able to make 10% on their investment
in the firm when selling it.
a) Compute the value of the firm if sold today (year 0), assuming it will
be liquidated (residual value = $0) at the end of phase 1. Why such
valuation would not make sense?
b) Under the going concern assumption, at which value will you be able
to sell the company at the end of phase 1 (year 5). Which cash flows
do you need to use? How would you call such cash flow stream?
c) Finally, compute the value of the firm if sold today (year 0) and under
the going concern assumption.
You are provided with the following forecasts (in millions) about
Metabolic Ltd., an American listed pharmaceutical company having 120
million shares outstanding.
– Current year’s (end-of-year) EBITDA is $1,000. You expect EBITDA
to increase by 10% during your explicit forecast period of 3 years.
– After the explicit forecast period, EBITDA growth rate will stabilize
at 3% until infinity.
– Depreciations and amortizations (D&As) amount to $150 each year,
and interest charges to $50. Tax rate is 25%.
– Cost of equity is 10% and cost of debt is 2%.
– The capital structure of Metabolic is made of 60% equity and 40%
debt. Assume it won’t change over time.
a) As an M&A investment banker, you are asked by a potential acquirer
to compare value Metabolic Ltd based on the Discounted Cash Flow
(DCF) method. What is your best approximation of the enterprise
value of Metabolic?
b) Assume that Metabolic’s net debt is $15,665, what is your best
approximation of the equity value and share price of Metabolic?
You want to value Kerlux SA, a French fashion company based in Europe.
You have extracted from S&P Capital IQ (financial database) trading
multiples for your peer group made of comparable fashion firms, and
computed the median for each of the following multiples as follows:
Median (peers) Multiple (LTM)
EV/EBITDA 13x
EV/EBIT 29x
P/E 38x
You have also estimated the relevant metrics of Kerlux as follows:
In $millions Metric (LTM)

EBITDA 60
EBIT 35
Earnings (15)
The firm has 20 million shares outstanding, a market value of debt of $100
million, and cash that amounts to $20 million.
What is the most relevant estimate of the stock price for Kerlux as of today
using the information above?
Please take into consideration that firms in the fashion industry have
different production models (i.e. some of them insource their production,
whereas some of them outsource their production).

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October 9th, 2018

SUMMARY BALANCE SHEET

d) Based on the above calculations, compute and interpret the evolution

You have also estimated the relevant metrics of Kerlux as follows:

In $millions Metric (LTM)

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