Question
question 1 You have recently started as an equity analyst at a large American bank. Your first task is to make a report on the
question 1
You have recently started as an equity analyst at a large American bank. Your first task is to
make a report on the Company A. The company distributes free
local newspapers in USA. From your initial analysis, you have made the following
forecast (all in million $):
Forecasts (million $, rounded to two decimals)
2022 | 2023 | 2024 | |
Sales | 30.00 | 28.00 | 25.00 |
Operating expenses | 26.50 | 25.00 | 22.30 |
Depreciation | 0.50 | 0.20 | 0.20 |
EBIT | 3.00 | 2.80 | 2.50 |
Interest expenses | 2.00 | 2.00 | 2.00 |
Tax | 0.23 | 0.18 | 0.11 |
Net income | 0.78 | 0.62 | 0.39 |
Capital expenditures | 5.00 | 1.00 | 1.00 |
Net working capital | 8.00 | 7.00 | 6.00 |
Assume that the first cash flow in column 2022 comes in one year from now, that the
growth rate in free cash flow from 2024 is 0% and that net working capital in 2021 is 10
million $.
Assume further that the risk-free rate is 2%, the expected return on the market is 5% and
that the corporate tax rate is 22.5%.
The companys cost of equity is 11%, the beta on equity is 3, the beta on debt is 0.5 and that
the company maintains a constant debttoequity ratio of 2.
State additional assumptions if needed.
Answer the following questions:
1. Calculate the asset beta of Company A and discuss what the magnitude can tell us about
the company
2. Calculate the free cash flows
3. Calculate the pretax cost of debt
4. Explain one other possible method of estimating the pretax cost of debt
5. Calculate the weighted average cost of capital (WACC)
6. Calculate the value of the firm using the discounted cash flow (DCF) analysis
7. Make a scenario analysis of your valuation as follows. Consider two scenarios. The
first scenario has a growth rate of free cash flows of 2% (and the same WACC). The
second scenario has a growth rate of 2% and a WACC of 7%. Compute the firm value
in each of these alternative scenarios and discuss reasons for doing this scenario
analysis.
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