Question 1 (24 Marks):

Wonderplayer develops video game products for consumers. In June 2012, a team of analysts issued a research report that valued Wonderplayers stock at $11.6 per share, compared to the then-current market price of $13. The research reports discounted cash flow valuation table is reproduced below. The 2012 figures are as reported by Wonderplayer, but the 2013 through 2020 figures are analysts forecasts. Key assumptions include a weighted average cost of capital of 10% and a perpetual growth rate of 2%. All dollar amounts are in millions except share value.

Required:

A, Comment on how the analyst of Wonderplayer calculate free cash flow compares with how the professional CFA might compute free cash flow directly from the companys financial statements. (4 marks)

b, What role does the 10% WACC play in the discounted cash flow valuation analysis? How about the role of WACC in the abnormal earnings valuation analysis? (2 mark)

c, Explain in detail to someone unfamiliar with present value calculations about how the Present value 20132020(i.e. $170.9977) is computed. (4 marks)

d, Explain in detail how the figure $468.7 for Present value beyond 2020 is computed. (5 marks)

e, Why does the analyst team subtract an amount for net debt in arriving at Equity value? (Note: The term net debt is defined for spreadsheet purposes as financial liabilities (e.g., loans) minus any financial assets (e.g., money market investments)) (2 marks)

f, What share value estimate would the Wonderplayer have calculated if they had used an abnormal earnings value approach rather than a discounted cash flow approach and had developed forecasts

g, Sometimes analysts research reports contain inadvertent computational errors. What would the estimated value of Wonderplayers stock have been if the analysts mistakenly used 60 million shares outstanding rather than the correct 50.35 million share count? (2 marks)

h, If you were the analyst of Wonderplayer in June 2012, what would be your investment recommendation advice to the investors of Wonderplayer based on your discounted cash flow valuation analysis? (2 marks)

Actual 2012 Total Revenues: EBITDA Capital expenditures Cash taxes Free cash flow Discount factor: Present value Present value beyond 2020 Present value 2013-2020 100 5.8 -0.2 -1.6 4 Analyst Forecast 2013 2014 2015 2016 2017 2018 2019 2020 127.3 224.4 336.1 590.2 680.5 785.1 903.2 1010.3 8.5 14.9 30.1 58.3 68.2 86.5 113.1 134.4 -1.7 -1.9 -2.3 -2.9 -3 -3.1 -3.3 -3.5 -2.1 -4.5 -10.8 -21.9 -25.6 -32.6 -43.5 -52.1 4.7 8.5 17 33.5 39.6 50.8 66.3 78.8 0.909091 0.826446 0.751315 0.683013 0.620921 0.564474 0.513158 0.466507 4.272727 7.024793 12.77235 22.88095 24.58848 28.67528 34.02238 36.76078 468.7 170.9977 639.6977 54.1 585.5977 50.35 11.63054 Less net debt Equity value Shares ourstanding Share value Actual 2012 Total Revenues: EBITDA Capital expenditures Cash taxes Free cash flow Discount factor: Present value Present value beyond 2020 Present value 2013-2020 100 5.8 -0.2 -1.6 4 Analyst Forecast 2013 2014 2015 2016 2017 2018 2019 2020 127.3 224.4 336.1 590.2 680.5 785.1 903.2 1010.3 8.5 14.9 30.1 58.3 68.2 86.5 113.1 134.4 -1.7 -1.9 -2.3 -2.9 -3 -3.1 -3.3 -3.5 -2.1 -4.5 -10.8 -21.9 -25.6 -32.6 -43.5 -52.1 4.7 8.5 17 33.5 39.6 50.8 66.3 78.8 0.909091 0.826446 0.751315 0.683013 0.620921 0.564474 0.513158 0.466507 4.272727 7.024793 12.77235 22.88095 24.58848 28.67528 34.02238 36.76078 468.7 170.9977 639.6977 54.1 585.5977 50.35 11.63054 Less net debt Equity value Shares ourstanding Share value