Q1 The following forecast is made for Kallang Ltd: 2021 $ 6.00 0.50 2022 $ 7.20 0.50 2023 $ 8.20 0.50 EPS (Earnings per Share) DPS (Dividends per Share) The ROCE (Return on Common Equity) for 2021 is 10% The expected market return is 6% and the risk-free return is 2%. Kallang Ltd has an equity beta of 2. Required: For Kallang Ltd: (a) Compute the AEG (Abnormal Earnings Growth) for 2022 and 2023. (10 marks) (b) Compute the normal forward P/E (price-earnings) ratio expected as at 1 Jan 2021, (1 mark) (c) Explain whether its forward P/E ratio should be higher or lower than the normal forward P.E. (5 marks) (d) Explain whether its PB (Price-to-Book) ratio at 1 Jan 2021 should be higher, lower or equal to 1. (5 marks) (e) Compute its earnings growth rate (ex-dividend) for 2022 and 2023. (2 marks) (0) Compute its earnings growth rate (cum-dividend) for 2022 and 2023 (this assumes shareholders would reinvest the dividends at the required return). (2 marks) Q3 (a) Sinkpost Ltd current market price is $15 per share, and its book value is $5 per share. Analysts forecast that the firm's book value will grow by 10 percent per year indefinitely, and the cost of equity is 15 percent. Given these facts, what is the market's expectation of the firm's long-term average ROCE? (5 marks) (b) Given the information in Question 4 (a), what will be Sinkpost's stock price if the market revises its expectations of long-term average ROCE to 20 percent? (5 marks) (c) Analysts reassess Sinkpost's future performance as follows: growth in book value increases to 12 percent per year, but the ROCE of the incremental book value is only 15 percent. What is the impact on the market-to-book ratio? (5 marks) (d) The Gong Tea Company plans to acquire Lau Lau Ice Cream Co. for $60 per share, a 50 percent premium over current market price. Lee Ho, the CFO of Gong Tea, argues that this valuation can easily be justified, using a price-earnings analysis. Gong Tea has a price-earnings ratio of 15, and we expect that we will be able to generate long-term earnings for Lau Lau Ice Cream of $5 per share. This implies that Lau Lau Ice Cream is worth $75 to us, well above our $60 offer price." Do you agree with this analysis? What are Lee Ho's key assumptions? (10 marks) 06 (a) A company New Drugs Ltd announces 15 million rise in profits. Is its stock price going to rise? (10 marks) (b) Assume New Medication Ltd is an identical company to New Drugs Ltd. The only difference between the two companies is that New Medication Ltd capitalises its R&D investments whereas New Drugs Ltd expenses them. In the same period when New Drugs Ltd announces 15 mln increase in earnings, New Medication Ltd announces 21 mln increase in eamings. How will the price of New Medication Ltd change relative to the price of New Drugs Ltd? (8marks) (c) Can accounting analysis improve accounting-based valuations? Why or why not? (7 marks) Q7 Extracts from the financial statements of Super Star plc for the year 2020 are shown below (values in m). Balance Sheet Extract 2019 Inventory 1,900 Trade payables (5,600) 2020 2,130 (6,200) Income Statement Extract 2020 Net Income Depreciation Interest expense 2,130 (780) (650) Cash Flow Statement Extract 2020 Capital expenditures Loan issues (1,380) (2,430) SuperStar's tax rate is 23%. Required: (a) Calculate the free cash flow available to equity of Super Star ple for the year 2020. (10 marks) (b) Assume that SuperStar's free cash flow available to equity, calculated in (a), will remain constant in the foreseeable future. SuperStar is currently valued at 20,000 million. What is the firm's implied cost of'equity capital? (5 marks) (c) Calculate the free cash flow available to debt and equity of SuperStar ple for the year 2020. (2 marks) (d) What discount factor should be used in discounting the forecasted free cash flows to debt and equity? (2 marks) (e) Assume that Super Star ple's cost of debt is 7%. Its debt-to-equity ratio is 40% and its weighted average cost of capital is 14%. If SuperStar plc changes its capital structure so that its debt-to-equity ratio is 30%, what should its new cost of equity be in order for the company to retain the same weighted average cost of capital? The cost of debt does not change. (6 marks) Q8 (a) What is fundamental information analysis? (5 marks) (b) What empirical evidence do Lev and Thiagarajan (1993) provide on the usefulness of fundamental financial statement information to analysts and investors? Explain. (12 marks) (c) Provide and discuss empirical evidence on returns to fundamental analysis as reported by Ou and Penman (1989). (8 marks) Q1 The following forecast is made for Kallang Ltd: 2021 $ 6.00 0.50 2022 $ 7.20 0.50 2023 $ 8.20 0.50 EPS (Earnings per Share) DPS (Dividends per Share) The ROCE (Return on Common Equity) for 2021 is 10% The expected market return is 6% and the risk-free return is 2%. Kallang Ltd has an equity beta of 2. Required: For Kallang Ltd: (a) Compute the AEG (Abnormal Earnings Growth) for 2022 and 2023. (10 marks) (b) Compute the normal forward P/E (price-earnings) ratio expected as at 1 Jan 2021, (1 mark) (c) Explain whether its forward P/E ratio should be higher or lower than the normal forward P.E. (5 marks) (d) Explain whether its PB (Price-to-Book) ratio at 1 Jan 2021 should be higher, lower or equal to 1. (5 marks) (e) Compute its earnings growth rate (ex-dividend) for 2022 and 2023. (2 marks) (0) Compute its earnings growth rate (cum-dividend) for 2022 and 2023 (this assumes shareholders would reinvest the dividends at the required return). (2 marks) Q3 (a) Sinkpost Ltd current market price is $15 per share, and its book value is $5 per share. Analysts forecast that the firm's book value will grow by 10 percent per year indefinitely, and the cost of equity is 15 percent. Given these facts, what is the market's expectation of the firm's long-term average ROCE? (5 marks) (b) Given the information in Question 4 (a), what will be Sinkpost's stock price if the market revises its expectations of long-term average ROCE to 20 percent? (5 marks) (c) Analysts reassess Sinkpost's future performance as follows: growth in book value increases to 12 percent per year, but the ROCE of the incremental book value is only 15 percent. What is the impact on the market-to-book ratio? (5 marks) (d) The Gong Tea Company plans to acquire Lau Lau Ice Cream Co. for $60 per share, a 50 percent premium over current market price. Lee Ho, the CFO of Gong Tea, argues that this valuation can easily be justified, using a price-earnings analysis. Gong Tea has a price-earnings ratio of 15, and we expect that we will be able to generate long-term earnings for Lau Lau Ice Cream of $5 per share. This implies that Lau Lau Ice Cream is worth $75 to us, well above our $60 offer price." Do you agree with this analysis? What are Lee Ho's key assumptions? (10 marks) 06 (a) A company New Drugs Ltd announces 15 million rise in profits. Is its stock price going to rise? (10 marks) (b) Assume New Medication Ltd is an identical company to New Drugs Ltd. The only difference between the two companies is that New Medication Ltd capitalises its R&D investments whereas New Drugs Ltd expenses them. In the same period when New Drugs Ltd announces 15 mln increase in earnings, New Medication Ltd announces 21 mln increase in eamings. How will the price of New Medication Ltd change relative to the price of New Drugs Ltd? (8marks) (c) Can accounting analysis improve accounting-based valuations? Why or why not? (7 marks) Q7 Extracts from the financial statements of Super Star plc for the year 2020 are shown below (values in m). Balance Sheet Extract 2019 Inventory 1,900 Trade payables (5,600) 2020 2,130 (6,200) Income Statement Extract 2020 Net Income Depreciation Interest expense 2,130 (780) (650) Cash Flow Statement Extract 2020 Capital expenditures Loan issues (1,380) (2,430) SuperStar's tax rate is 23%. Required: (a) Calculate the free cash flow available to equity of Super Star ple for the year 2020. (10 marks) (b) Assume that SuperStar's free cash flow available to equity, calculated in (a), will remain constant in the foreseeable future. SuperStar is currently valued at 20,000 million. What is the firm's implied cost of'equity capital? (5 marks) (c) Calculate the free cash flow available to debt and equity of SuperStar ple for the year 2020. (2 marks) (d) What discount factor should be used in discounting the forecasted free cash flows to debt and equity? (2 marks) (e) Assume that Super Star ple's cost of debt is 7%. Its debt-to-equity ratio is 40% and its weighted average cost of capital is 14%. If SuperStar plc changes its capital structure so that its debt-to-equity ratio is 30%, what should its new cost of equity be in order for the company to retain the same weighted average cost of capital? The cost of debt does not change. (6 marks) Q8 (a) What is fundamental information analysis? (5 marks) (b) What empirical evidence do Lev and Thiagarajan (1993) provide on the usefulness of fundamental financial statement information to analysts and investors? Explain. (12 marks) (c) Provide and discuss empirical evidence on returns to fundamental analysis as reported by Ou and Penman (1989). (8 marks)