(a) Biscay Ltd is a monopoly protected by law. The equity figure in its most recent balance sheet was S150 million while the book value of debt was 560 million. This is also the market value of the debt. The firm's cost of equity is 15% and pretax cost of debt is 10%. The firm has 15 million shares outstanding. Biscay's sales and costs, each year into the distant future are expect to be, on average, as follows: Sales $120 million, Cost of goods sold 544 million, Administrative costs $12 million, Depreciation expense $20 million and the annual Interest expense is $6 million. The corporate tax rate is 40 cents in the dollar and Biscay Ltd pays a steady 20 cents per share dividend each year Required: Use the Discounted Abnormal Earnings valuation model to calculate the value of a Biscay share. (6 marks) (ii) It is possible to value the debt and equity of Biscay Ltd combined if we use a second model, the Discounted Earnings model. Please use the Biscay Ltd data in Part (a) and the Discounted Earnings Model to calculate the dollar value of this fim's debt and equity (combined). (7 marks) Torrent Ltd has a patent that is going to expire at the end of three years from now. The equity figure in its most recent balance sheet was $60 million while its book value of debt was 540 million. The firm has a cost of equity of 10% and a pretax cost of debt of 5%. There are 10 million shares outstanding. Torrent's earnings before interest, tax and depreciation (EBITD) are expected to be constant each year of this three-year period at $70 million while Torrent's Depreciation expense will remain constant at $25 million per year over the period. Torrent's Interest expense will also remain constant, at $2 million per year. When the patent expires, Torrent Ltd's abnormal earnings are expected to reduce each ensuing year by 30 percent (such that each year's abnormal earnings figure will be 70 percent of the one before it.) The corporate tax rate is 40 cents on the dollar and Torrent pays a constant dividend of 50 cents per share each year.. Required: Use the Discounted Abnormal Earnings valuation model to calculate the value of a Torrent share. (7 marks) (b) If the abnormal earnings had been a perpetuity as the question seemed to suggest, then the value of AE equity would have been calculated as: Vigum = BVE + However, the specified dividend introduced a very nasty fish-hook into this question. The value o equity, instead had to be calculated as =BVE+ AE |PV 0 EOLITY = BVE + [NPAT, r,BVE] ... and a growth rate had to be calculated. (a) Biscay Lid N BVE 15,000,000 150,000,000 60,000,000 0.15 0.1 0.4 0.124285714 tc Therefore WACC rBVA, BVE 0 22,500,000 dividend payout per share 0.20 Sales Cost of good sold Admin costs Depreciation Interest expense ET- Tax expense therefore NPAT Dividend @ 0.2 Delta RE- 120,000,000 44,000,000 12,000,000 20.000.000 6,000,000 38,000,000 15,200,000 22,800,000 3,000,000 19,800,000 First we need a measure of the growth rate in the book value of equity. Note that the wording of the question fixes the value of NPAT as an unchanging figure. This means that the growth of BVE exactly reduces AE. Please interpret "decay" here as a negative growth rate implying that the next AE will be 86.8% of the size of the first AE. PV EQUITY = BVE AE Is-g ROENPAT/ VOPENINGEQUITY d (1-d) Therefore SVE ONLY Therefore decay of AE= 0.152 0.131578947 0.868421053 0.132 -0.132 [NPAT, r;BVE] = BVE, + 150,000,000 300,000 BVE. (brought down) = AE = NPAT - rsBVEo = PV of horizon value only = Add BVE. N (brought down) = Therefore Po 1,063,830 151,063,830 15,000,000 10.07 First we need a measure of the growth rate in the book value of equity. Note that the wording of the question fixes the value of NPAT as an unchanging figure. This means that the growth of BVE exactly reduces AE. Please interpret "decay" here as a negative growth rate implying that the next AE will be 86.8% of the size of the first AE. PV EQUITY = BVE AE Is-g ROENPAT/ VOPENINGEQUITY d (1-d) Therefore SVE ONLY Therefore decay of AE= 0.152 0.131578947 0.868421053 0.132 -0.132 [NPAT, r;BVE] = BVE, + 150,000,000 300,000 BVE. (brought down) = AE = NPAT - rsBVEo = PV of horizon value only = Add BVE. N (brought down) = Therefore Po 1,063,830 151,063,830 15,000,000 10.07
