| | Wheeler Analytics is a firm providing valuation services to parties seeking investment in private companies. Gina Silverstein is working alongside her subordinate, Rita Mendez, in attempting to value three privately traded firms. Mendez has collected data with respect to the firms in Exhibit 1. Exhibit 1: Privately Traded Firms Subject to Valuation Exhibit 1: Privately Traded Firms Subject to Valuation | Firms | Details | | BRIC Ltd | BRIC is currently operating under bankruptcy protection. The analyst would like to assess whether the company is more valuable as a going concern or in liquidation. | | Zeta | Zeta is a biotechnology startup which is receiving financing from Grack, a venture capital fund. Zetas products are currently in their development phase. Company management intends to launch product prototypes in the market within the next six months. | | Quanto | Quanto is in the shipping and courier delivery business, an industry comprising numerous public and private courier delivery providers. Quanto owns several shipyards across the country and these sites are currently being used to deliver parcels to recipients located in different countries. The firm is currently in a rapid growth stage which is expected to slow down five years from today. | Silverstein concludes that the free cash flow (FCF) approach will be most suitable for valuing Quanto. Mendez asks Silverstein why she has opted for this approach. The two analysts proceed to apply the FCF approach for valuing Quanto. Prior to applying the approach, Silverstein decides to normalize the companys earnings in order to make the reported income more relevant from the perspective of a prospective buyer and for forecasting future earnings. In response to Silversteins instructions, Mendez collects selective current year income statement data in Exhibit 2 as well as facts which may be useful in adjusting reporting earnings in Exhibit 3. | Exhibit 2: Current Year Income Statement Data (In 000s) | Revenue | $58,000 | | Cost of goods sold | $37,700 | | Gross profit | $20,300 | | Selling, general and administrative expenses (SG&A) | $3,900 | | Earnings before interest, tax, depreciation and amortization (EBITDA) | $16,400 | | Depreciation and amortization | $9,900 | | Earnings before interest and taxes (EBIT) | $6,500 | | Taxes | $1,950 | | Operating income after taxes | $4,550 | Exhibit 3: Collected Facts | Quantos CEOs annual compensation is 20% greater than the market average. The annual compensation paid to the CEO in the current year was $2.0 million and is recorded in SG&A. | | Depreciation expense related to property, plant and equipment sold during the year amounted to $200,000. The gain generated from the sale amounts to $800,000 and is recorded as part of nonoperating income. | | The company entered into a life insurance scheme on behalf of its shareholders. The premium paid in the current year amounted to $350,000 and was recorded as part of SG&A. | The analysts proceed to compute a pro-forma FCF for the firm for the following year using the following assumptions: - Revenue is expected to grow by 5% in the following year.
- SG&A expenses are expected to increase by 2%.
- Gross margin will remain at 35% of sales.
- Depreciation will remain at 2.0% of sales.
- Incremental investment in working capital is equal to 10% of the increase in revenue from the previous year.
- Capital expenditures to support current operations are expected to remain at $650,000 while those required to promote future growth will equal 8% of the increase in revenues.
The analysts build on their analysis of the FCF approach by evaluating the suitability of the FCFF and FCFE approaches. They project that the capital structure is expected to undergo significant changes as the company undertakes an IPO of its stock at the end of the forecast horizon. | Question | | Which of the following reasons will most likely underlie the analysts valuation of BRIC Ltd? | -
A. Compliance-related -
B. Transaction-related -
C. Litigation-related Question | | Which of the following valuation approaches is most suitable for Zeta? | -
A. Asset-based approach -
B. Market approach -
C. Income approach Question | | Which of the following reasons most likely supports Silversteins preference of the FCF approach for valuing Quanto? | -
A. Cash flow growth is unstable during the initial forecast period. -
B. Market pricing data from public companies is readily available. -
C. Operations are expected to become stable in the future. Question | | Using the data in Exhibits 2 and 3, Quantos normalized earnings for the current year is closest to (in $000s): | -
A. $5,950. -
B. $5,075. -
C. $5,215. Question | | Based on the listed assumptions and using the data in Exhibit 2, the FCF projected for the following year (based on reporting earnings) is closest to (in 000s): | -
A. $11,329. -
B. $16,245. -
C. $11,283 Question | | Based on the projected change in the capital structure, the most suitable valuation approach according to the general perception amongst analysts is the: | -
A. B. FCFF; which is more favorable for large, high growth firms such as Quanto. -
B. FCFE; which represents the return to a companys equity holders -
C. FCFF; which is more robust when there are substantial capital structure changes. |
