Valuation and use of free cash flows

AFM – May 2019 – L3 – Q5b – Valuation and use of free cash flows

Evaluate whether Senchi Ltd is a good investment for Kurablah based on the Dividend Growth Model and calculate the maximum price she should pay.

Question

Rosa Kurablah Ltd (Kurablah) plans to invest in ordinary shares for a period of fifteen years, after which she will sell out, buy a lifetime room and board membership in a retirement home, and retire. She feels that Senchi Ltd (Senchi) is currently, but temporarily, undervalued by the market. Kurablah expects Senchi’s current earnings and dividend to double in the next fifteen years. Senchi’s last dividend was GH¢3, and its stock currently sells for GH¢35 a share.

Required:

i) If Kurablah requires a 12 percent return on her investment, will Senchi be a good buy for her?
(3 marks)

ii) What is the maximum that Kurablah could pay for Senchi and still earn her required 12 percent?
(2 marks)

iii) What might be the cause of such a market undervaluation?
(3 marks)

iv) Given Kurablah’s assumptions, what market capitalization rate for Senchi does the current price imply?

Answer

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Tags: Dividend growth model, Investment Decision, Market capitalization, Required Return, Stock valuation
Level: Level 3

Topic: Valuation and use of free cash flows
Series: MAY 2019

AFM – Nov 2018 – L3 – Q3b -Valuation and use of free cash flows

Estimate the value of the firm and its equity using the FCFF and FCFE valuation approaches and calculate the value per share.

Question

DoGood Ltd is evaluating Phinex Ltd using the Free Cash Flow to the Firm (FCFF) and Free Cash Flow to Equity (FCFE) valuation approaches.

DoGood Ltd has gathered the following information (in current Ghana Cedis terms):

Phinex Ltd has net income of GH¢250 million, depreciation of GH¢90 million, capital expenditures of GH¢170 million, and an increase in working capital of GH¢40 million.
Phinex Ltd will finance 40% of the increase in net fixed assets (capital expenditures less depreciation) and 40% of the increase in working capital with debt financing.
Interest expenses are GH¢150 million. The current market value of Phinex’s outstanding debt is GH¢1,800 million.
FCFF is expected to grow at 6.0% indefinitely, and FCFE is expected to grow at 7.0%.
The tax rate is 30%.
Phinex Ltd is financed with 40% debt and 60% equity. The before-tax cost of debt is 9% and the before-tax cost of equity is 13%.
Phinex Ltd has 10 million outstanding shares.

Required:
i) Using the FCFF valuation approach, estimate the total value of the firm, the total market value of equity, and the value per share.
(6 marks)

ii) Using the FCFE valuation approach, estimate the total market value of equity and the value per share.
(6 marks)

Answer

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Tags: Cost of Capital, FCFE, FCFF, Free Cash Flow, Valuation, Value per Share
Level: Level 3

Topic: Valuation and use of free cash flows
Series: NOV 2018

AFM – May 2018 – L3 – Q2 – Discounted cash flow techniques | Valuation and the use of free cash flows

Evaluating investment options using NPV and IRR to advise a company on which projects should be undertaken.

Question

The Board of Peartek Ltd is considering the company’s capital investment options for the coming year, and is evaluating the following potential investments:

Investment A:

Investment of GH¢60,000, including GH¢40,000 for capital equipment and GH¢20,000 for increases in working capital.
Expected sales of 10,000 units next year with a sales price of GH¢10 and variable costs of GH¢6 per unit.
Sales price is expected to decline by 20% per annum due to competition, sales volume to fall by 10%, and variable costs to decline by 20%.
Overheads of GH¢15,000 annually, including a GH¢4,000 depreciation charge.
The project will be wound up in year three, with working capital recovered and capital equipment sold off for 25% of its cost.

Investment B:

Immediate outlay of GH¢90,000, financed by borrowing at 6%.
Expected net profits of GH¢12,000 next year, rising by 3% per annum indefinitely.

Investment C:

Outlay of GH¢25,000 financed by retained profits.
Expected annual net cash profits:
- Years 1 to 4: GH¢3,000
- Years 5 to 7: GH¢5,000
- From year 8 onwards: GH¢7,000 in perpetuity.

The company discounts projects lasting 10 years or less at 10%, and others at 13%. Ignore taxation.

Required:

a) As a financial management analyst, you have been asked to advise the board of Peartek Ltd (in the form of a briefing report) which investment should be undertaken. Use the NPV method in your analysis. (15 marks)

b) Minority of board members feel that the Internal Rate of Return (IRR) should also be used as either an alternative or a complementary method of investment appraisal. Calculate the IRR of investments A and B and comment accordingly. (5 marks)

Answer

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Tags: Capital Budgeting, Internal Rate of Return (IRR), Investment Appraisal, Net Present Value (NPV)
Level: Level 3

Topic: Discounted cash flow techniques, Valuation and use of free cash flows
Series: MAY 2018

AFM – May 2016 – L3 – Q2a – Discounted cash flow techniques, Valuation and use of free cash flows, Theories of capital structure

Compute NPV for two investment projects using WACC and CAPM, and provide recommendations based on risk analysis.

Question

a) Joebel Limited is a diversified company operating in different industries on the African Continent. The shares of the company are widely traded on the stock exchange and currently have a market price of GH¢3.20 per share. The company’s dividend payment over the last five years is as follows:

Year	Dividend Per Share (DPS) (GH¢)
2015	0.35
2014	0.32
2013	0.30
2012	0.29
2011	0.28

The Board of Directors of Joebel Limited is considering two main investment opportunities: one in the Oil and Gas sector and the other in the Hotel and Tourism sector. Both projects have short lives and their associated cash flows are as follows:

Year	Oil & Gas (GH¢’000)	Hotel & Tourism (GH¢’000)
1	85	180
2	175	195
3	160	150

The investment in Oil and Gas would cost GH¢400,000, while the investment in Hotel and Tourism would cost GH¢405,000. The Management of the Company has identified the industry beta for Oil and Gas as 1.2 and for Hotel and Tourism as 1.6. However, Joebel Limited’s company beta is 1.5. The average return on companies listed on the stock exchange is 25%, and the yield on Treasury bills is 20%.

Required:
i) Compute the Net Present Values (NPV) of both projects using the company’s weighted average cost of capital as the discount rate. (5 marks)
ii) Compute the NPV using a discount rate that takes into account the risk associated with the individual projects. (5 marks)
iii) Advise Management regarding the suitability and acceptability of the projects. (1 mark)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Cost of Capital, Hotel & Tourism, Investment Appraisal, Net Present Value (NPV), Oil & Gas, Risk
Level: Level 3

Topic: Discounted cash flow techniques, Valuation and use of free cash flows
Series: MAY 2016

AFM – May 2019 – L3 – Q5b – Valuation and use of free cash flows

Evaluate whether Senchi Ltd is a good investment for Kurablah based on the Dividend Growth Model and calculate the maximum price she should pay.

Question

Required:

i) If Kurablah requires a 12 percent return on her investment, will Senchi be a good buy for her?
(3 marks)

ii) What is the maximum that Kurablah could pay for Senchi and still earn her required 12 percent?
(2 marks)

iii) What might be the cause of such a market undervaluation?
(3 marks)

iv) Given Kurablah’s assumptions, what market capitalization rate for Senchi does the current price imply?

Answer

Find Related Questions by Tags, levels, etc.

Tags: Dividend growth model, Investment Decision, Market capitalization, Required Return, Stock valuation
Level: Level 3

Topic: Valuation and use of free cash flows
Series: MAY 2019

AFM – Nov 2018 – L3 – Q3b -Valuation and use of free cash flows

Estimate the value of the firm and its equity using the FCFF and FCFE valuation approaches and calculate the value per share.

Question

DoGood Ltd is evaluating Phinex Ltd using the Free Cash Flow to the Firm (FCFF) and Free Cash Flow to Equity (FCFE) valuation approaches.

DoGood Ltd has gathered the following information (in current Ghana Cedis terms):

Phinex Ltd has net income of GH¢250 million, depreciation of GH¢90 million, capital expenditures of GH¢170 million, and an increase in working capital of GH¢40 million.
Phinex Ltd will finance 40% of the increase in net fixed assets (capital expenditures less depreciation) and 40% of the increase in working capital with debt financing.
Interest expenses are GH¢150 million. The current market value of Phinex’s outstanding debt is GH¢1,800 million.
FCFF is expected to grow at 6.0% indefinitely, and FCFE is expected to grow at 7.0%.
The tax rate is 30%.
Phinex Ltd is financed with 40% debt and 60% equity. The before-tax cost of debt is 9% and the before-tax cost of equity is 13%.
Phinex Ltd has 10 million outstanding shares.

Required:
i) Using the FCFF valuation approach, estimate the total value of the firm, the total market value of equity, and the value per share.
(6 marks)

ii) Using the FCFE valuation approach, estimate the total market value of equity and the value per share.
(6 marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Cost of Capital, FCFE, FCFF, Free Cash Flow, Valuation, Value per Share
Level: Level 3

Topic: Valuation and use of free cash flows
Series: NOV 2018

AFM – May 2018 – L3 – Q2 – Discounted cash flow techniques | Valuation and the use of free cash flows

Evaluating investment options using NPV and IRR to advise a company on which projects should be undertaken.

Question

The Board of Peartek Ltd is considering the company’s capital investment options for the coming year, and is evaluating the following potential investments:

Investment A:

Investment of GH¢60,000, including GH¢40,000 for capital equipment and GH¢20,000 for increases in working capital.
Expected sales of 10,000 units next year with a sales price of GH¢10 and variable costs of GH¢6 per unit.
Sales price is expected to decline by 20% per annum due to competition, sales volume to fall by 10%, and variable costs to decline by 20%.
Overheads of GH¢15,000 annually, including a GH¢4,000 depreciation charge.
The project will be wound up in year three, with working capital recovered and capital equipment sold off for 25% of its cost.

Investment B:

Immediate outlay of GH¢90,000, financed by borrowing at 6%.
Expected net profits of GH¢12,000 next year, rising by 3% per annum indefinitely.

Investment C:

Outlay of GH¢25,000 financed by retained profits.
Expected annual net cash profits:
- Years 1 to 4: GH¢3,000
- Years 5 to 7: GH¢5,000
- From year 8 onwards: GH¢7,000 in perpetuity.

The company discounts projects lasting 10 years or less at 10%, and others at 13%. Ignore taxation.

Required:

Answer

Find Related Questions by Tags, levels, etc.

Tags: Capital Budgeting, Internal Rate of Return (IRR), Investment Appraisal, Net Present Value (NPV)
Level: Level 3

Topic: Discounted cash flow techniques, Valuation and use of free cash flows
Series: MAY 2018

AFM – May 2016 – L3 – Q2a – Discounted cash flow techniques, Valuation and use of free cash flows, Theories of capital structure

Compute NPV for two investment projects using WACC and CAPM, and provide recommendations based on risk analysis.

Question

Year	Dividend Per Share (DPS) (GH¢)
2015	0.35
2014	0.32
2013	0.30
2012	0.29
2011	0.28

Year	Oil & Gas (GH¢’000)	Hotel & Tourism (GH¢’000)
1	85	180
2	175	195
3	160	150

Answer

Find Related Questions by Tags, levels, etc.

Tags: Cost of Capital, Hotel & Tourism, Investment Appraisal, Net Present Value (NPV), Oil & Gas, Risk
Level: Level 3

Topic: Discounted cash flow techniques, Valuation and use of free cash flows
Series: MAY 2016

Topic: Valuation and use of free cash flows

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AFM – May 2019 – L3 – Q5b – Valuation and use of free cash flows

Evaluate whether Senchi Ltd is a good investment for Kurablah based on the Dividend Growth Model and calculate the maximum price she should pay.

AFM – Nov 2018 – L3 – Q3b -Valuation and use of free cash flows

Estimate the value of the firm and its equity using the FCFF and FCFE valuation approaches and calculate the value per share.

AFM – May 2018 – L3 – Q2 – Discounted cash flow techniques | Valuation and the use of free cash flows

Evaluating investment options using NPV and IRR to advise a company on which projects should be undertaken.

Investment A:

Investment B:

Investment C:

AFM – May 2016 – L3 – Q2a – Discounted cash flow techniques, Valuation and use of free cash flows, Theories of capital structure

Compute NPV for two investment projects using WACC and CAPM, and provide recommendations based on risk analysis.

AFM – May 2019 – L3 – Q5b – Valuation and use of free cash flows

Evaluate whether Senchi Ltd is a good investment for Kurablah based on the Dividend Growth Model and calculate the maximum price she should pay.

AFM – Nov 2018 – L3 – Q3b -Valuation and use of free cash flows

Estimate the value of the firm and its equity using the FCFF and FCFE valuation approaches and calculate the value per share.

AFM – May 2018 – L3 – Q2 – Discounted cash flow techniques | Valuation and the use of free cash flows

Evaluating investment options using NPV and IRR to advise a company on which projects should be undertaken.

Investment A:

Investment B:

Investment C:

AFM – May 2016 – L3 – Q2a – Discounted cash flow techniques, Valuation and use of free cash flows, Theories of capital structure

Compute NPV for two investment projects using WACC and CAPM, and provide recommendations based on risk analysis.

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AFM – May 2019 – L3 – Q5b – Valuation and use of free cash flows

Evaluate whether Senchi Ltd is a good investment for Kurablah based on the Dividend Growth Model and calculate the maximum price she should pay.

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AFM – Nov 2018 – L3 – Q3b -Valuation and use of free cash flows

Estimate the value of the firm and its equity using the FCFF and FCFE valuation approaches and calculate the value per share.

You're reporting an error for "AFM – Nov 2018 – L3 – Q3b -Valuation and use of free cash flows"

AFM – May 2018 – L3 – Q2 – Discounted cash flow techniques | Valuation and the use of free cash flows

Evaluating investment options using NPV and IRR to advise a company on which projects should be undertaken.

Investment A:

Investment B:

Investment C:

You're reporting an error for "AFM – May 2018 – L3 – Q2 – Discounted cash flow techniques | Valuation and the use of free cash flows"

AFM – May 2016 – L3 – Q2a – Discounted cash flow techniques, Valuation and use of free cash flows, Theories of capital structure

Compute NPV for two investment projects using WACC and CAPM, and provide recommendations based on risk analysis.

You're reporting an error for "AFM – May 2016 – L3 – Q2a – Discounted cash flow techniques, Valuation and use of free cash flows, Theories of capital structure"

AFM – May 2019 – L3 – Q5b – Valuation and use of free cash flows

Evaluate whether Senchi Ltd is a good investment for Kurablah based on the Dividend Growth Model and calculate the maximum price she should pay.

You're reporting an error for "AFM – May 2019 – L3 – Q5b – Valuation and use of free cash flows"

AFM – Nov 2018 – L3 – Q3b -Valuation and use of free cash flows

Estimate the value of the firm and its equity using the FCFF and FCFE valuation approaches and calculate the value per share.

You're reporting an error for "AFM – Nov 2018 – L3 – Q3b -Valuation and use of free cash flows"

AFM – May 2018 – L3 – Q2 – Discounted cash flow techniques | Valuation and the use of free cash flows

Evaluating investment options using NPV and IRR to advise a company on which projects should be undertaken.

Investment A:

Investment B:

Investment C:

You're reporting an error for "AFM – May 2018 – L3 – Q2 – Discounted cash flow techniques | Valuation and the use of free cash flows"

AFM – May 2016 – L3 – Q2a – Discounted cash flow techniques, Valuation and use of free cash flows, Theories of capital structure

Compute NPV for two investment projects using WACC and CAPM, and provide recommendations based on risk analysis.

You're reporting an error for "AFM – May 2016 – L3 – Q2a – Discounted cash flow techniques, Valuation and use of free cash flows, Theories of capital structure"

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