Extra-Credits Take-Home Exam

Each question below carries 10 points. UNLIKE a timed exam, you will need to show all steps to
get points for your answer. Just a final (correct) answer will carry very no points.
A firm you are analyzing as a senior analyst has these forecasted free cash flows:
Year
Free Cash Flows in millions of $

1
-25

2
-10

3
30

4
40

1. Steels weighted average cost of capital is 12%. Its free cash flows will grow by 4% per
year forever after year 4. It has marketable securities worth 40 million. It has total debt
worth 75 million but no preferred stock. It has 5 million shares outstanding. What should
be the price per share according to the Free Cash Flow model?
2. What would be Steels price per share if the growth rate in free cash flows was 10%?

The data below belongs to Acme Inc. All numbers are actual (not in thousands). Year 2014 is
year zero (now) and 2015 is year 1.
INCOME STATEMENT
Total Revenue
Cost of Revenue
Gross Profit
Selling General and
Administrative
Non Recurring
Others
Total Operating Expenses
Operating Income or Loss
Income from Continuing
Operations
Earnings Before Interest And
Taxes
Interest Expense
Income Before Tax
Income Tax Expense
Minority Interest
Net Income From Continuing Ops
Net Income
Depreciation
Dividends Paid
1

2015
321530000
202446667
119083333

2014
324286000
204534667
119751333

54562667

58972667

1226667
10592000
52702000

1387333
10388667
49002667

52702000

49002667

218000
52484000
20696667
-1867333
29920000
29920000
10592000
6946000

164667
48838000
20700667
-764000
27373333
27373333
10388667
6217333

BALANCE SHEET
Assets
Current Assets
Cash And Cash Equivalents
Short Term Investments
Net Receivables
Inventory
Other Current Assets
Total Current Assets
Long Term Investments
Property Plant and Equipment
Other Assets

2015

2014

6615333
23324667
9694667
3338667
42973333
23145333
151299333
5112000

8712000
25761333
10016000
4152667
48642000
22888667
143109333
6061333

Total Assets

222530000

220701333

40324000
2435333
42759333
5285333
34998667
25046667
3864667
111954667

46529333
5140667
51670000
6214667
31242000
24412000
4232000
117770667

6435333
243818000
-131555333

6341333
220626000
-117954667

-8122667

-6082000

Total Stockholder Equity

110575333

102930667

Total Stockholder Equity and Liabilities

222530000

220701333

Liabilities
Current Liabilities
Accounts Payable
Short/Current Long Term Debt
Other Current Liabilities
Total Current Liabilities
Long Term Debt
Other Liabilities
Deferred Long Term Liability Charges
Minority Interest
Negative Goodwill
Total Liabilities
Stockholders' Equity
Preferred Stock
Common Stock
Retained Earnings
Treasury Stock
Other Stockholder Equity

3.
a) Calculate the free cash flow available to all investors of Acme Inc. for the year
2015. Hint: chapter 7 uses these free cash flows but chapter 2 explains how to
calculate them.
b) Acmes weighted average cost of capital is 15%. Its cash flow is supposed to
grow at 5% per year from 2014 onwards (constant growth from the get go). What
is the value from operations for Acme Inc.? As you can see from the balance
sheet, Acme has no marketable securities so its value from operations is also its
total value.
4.
a) If Acme Inc. has 5 million shares outstanding, what should be the price per share
of its common stock according to the Free Cash Flow Valuation model? Not that
Acme has no preferred stock but it has both short-term and long term debt today
(2014).
b) What is the book value per share for Acme and what is the price/book multiple for
it?

5. Why are employee stock options always call options and never puts? What is wrong in
giving put options to employees?

6. Why is it so difficult to calculate market risk premium in the real world? Why is not okay
to just use historical (past) market risk premium? (Hint: read the book section on it.)

7. Why does an NPV profile of two projects cross over? When would it not cross over?

8. What is the difference between the sensitivity analysis and scenario analysis?

9. What is the difference between sunk cost and opportunity cost? Why is sunk cost ignored
but opportunity cost included in projects cash flows even though you might not be
paying them out of pocket in either case?

10. Why should you include flotation cost in calculating the cost of common stock, preferred
stock, or debt? How do these costs change as a result of this inclusion? Which source of
long-term capital for a firm does not cost any flotation costs?

Smithy Inc. has developed a new car engine. It would cost $22 million at Year 0 to buy the
equipment necessary to manufacture the server. The project would require net working capital at
the beginning of each year in an amount equal to 12% of the year's projected sales; for example,
NWC0 = 12%(Sales1). The engine would sell for $10,000 per unit, and Smithy Inc. believes
that variable costs would amount to $5,500 per unit. After Year 1, the sales price and variable
costs will increase at the inflation rate of 4%. The companys non-variable costs (fixed costs
without depreciation) would be $2 million at Year 1 and would increase with inflation.
The server project would have a life of 4 years. If the project is undertaken, it must be continued
for the entire 4 years. Also, the project's returns are expected to be highly correlated with returns
on the firm's other assets. The firm believes it could sell 1,500 units per year.
The equipment would be depreciated over a 5-year period, using MACRS rates (given in the
book in the solved example for chapter 11). The estimated market value of the equipment at the
end of the projects 4-year life is $2 million. Smithy Inc.s federal-plus-state tax rate is 40%. Its
cost of capital is 12% for average-risk projects, defined as projects with a coefficient of variation
of NPV between 0.8 and 1.2. Low-risk projects are evaluated with a WACC of 10%, and highrisk projects at 14%.
11. Calculate the net cash flows for Smithys new project. Based on its NPV should the
project be taken?
12. Calculate the MIRR of these cash flows without using Excel. Show all your intermediate
steps. The cost of capital for this firm is 10%. Would you accept this project? Why?
year
0
1
2
3
4
5
6
7
8
9

Cash flow
-100
80
30
60
-10
-20
50
70
90
-10
4