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    Closure in Valuation: Estimating Terminal Value: Problem 1

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    Silviu Trebuian
    This document discusses several problems involving estimating terminal value in valuation. Problem 1 calculates terminal value using a constant growth model. Problem 2 calculates terminal value using different growth and reinvestment rates. Problem 3 explores the impact of changing return on capital on terminal value. Problem 4 values a company using a dividend discount model. Problem 5 examines the impact of changing capital expenditures on terminal value. Problem 6 analyzes partial liquidations. Problem 7 demonstrates how higher growth rates impact terminal value when return on capital exceeds cost of capital.

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    Closure in Valuation: Estimating Terminal Value: Problem 1

    Uploaded by

    Silviu Trebuian
    32 views3 pages
    This document discusses several problems involving estimating terminal value in valuation. Problem 1 calculates terminal value using a constant growth model. Problem 2 calculates terminal value using different growth and reinvestment rates. Problem 3 explores the impact of changing return on capital on terminal value. Problem 4 values a company using a dividend discount model. Problem 5 examines the impact of changing capital expenditures on terminal value. Problem 6 analyzes partial liquidations. Problem 7 demonstrates how higher growth rates impact terminal value when return on capital exceeds cost of capital.

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    ch12sol

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    This document discusses several problems involving estimating terminal value in valuation. Problem 1 calculates terminal value using a constant growth model. Problem 2 calculates terminal value using different growth and reinvestment rates. Problem 3 explores the impact of changing return on capital on terminal value. Problem 4 values a company using a dividend discount model. Problem 5 examines the impact of changing capital expenditures on terminal value. Problem 6 analyzes partial liquidations. Problem 7 demonstrates how higher growth rates impact terminal value when return on capital exceeds cost of capital.

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    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    32 views3 pages

    Closure in Valuation: Estimating Terminal Value: Problem 1

    Uploaded by

    Silviu Trebuian
    This document discusses several problems involving estimating terminal value in valuation. Problem 1 calculates terminal value using a constant growth model. Problem 2 calculates terminal value using different growth and reinvestment rates. Problem 3 explores the impact of changing return on capital on terminal value. Problem 4 values a company using a dividend discount model. Problem 5 examines the impact of changing capital expenditures on terminal value. Problem 6 analyzes partial liquidations. Problem 7 demonstrates how higher growth rates impact terminal value when return on capital exceeds cost of capital.

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    CHAPTER 12 CLOSURE IN VALUATION: ESTIMATING TERMINAL VALUE

    Problem 1 a. Operating income in year 5 = 100 million (1.1)5 = $ 161.05 million Terminal value (year 5) = 161.05 * 8 = $1288.41 million b. Value/ EBIT = (1- t) (1 g/ ROC)/ (Cost of capital g) 8 = (1.4) (1-.05/ROC)/ (.10 - .05) Solving for ROC, ROC = .15 or 15% Problem 2 Expected EBIT in year 6 = 80 (1.20)5 (1.05) = $209.02 million Expected EBIT (1-t) in year 6 = $209.02 (1 - .40) = $125.41 million Reinvestment rate in year 6 = g/ ROC = 5/14 = 35.71% Terminal value = $125.41 (1-.3571)/ (.10-.05) = $1612.43 million Problem 3 a. Expected stable growth rate = ROC* Reinvestment rate = 15% .30 = 4.5% Expected high growth rate = .80 *.15 = 12% EBIT (1-t) in year 5 = (.15*100) (1.12)4 (1.045) = $24.66 million Terminal value = 24.66 (1-.30)/(.09-.045) = $383.60 million a. If return on capital drops to 9%, you can re-estimate value by either changing the reinvestment rate (keeping growth at 4.5%) or changing the growth rate (keeping the reinvestment rate at 30%). If growth rate is kept fixed, Reinvestment rate = 4.5/9 = 50% Terminal value = 24.66 (1-.50)/(.09- .045) = $274 million If reinvestment rate is kept fixed, Expected growth rate = 9% (.30) = 2.7% EBIT (1-t) in year 5 = (.15*100) (1.12)4 (1.027) = $24.24 million Terminal value = 24.24 (1-.30)/(.09-.027) = $269.33 million Problem 4 a. Terminal value = 500 (1.03)10 = $671.96 million

    Dividend Discount Models

    a. After-tax operating income in year 10 = 50 (1.08)10 = $107.95 million Terminal Value/ After-tax operating income = 671.96/107.95 = 6.22 b. Value = EBIT (1-t) (1+g)/ (r g) Value/ EBIT (1-t) = (1+g)/ (r g) 6.22 = 1.03/ (r - .03) Solving for r, cost of capital = 13.55% Problem 5 a. After-tax operating income in year 6 = 20 (1.1)5 (1.04) = $ 33.50 million Net Cap ex in year 6 = (15-5) (1.1)5 (1.04) = $16.75 million Free cashflow to the firm in year 6 = $16.75 million Terminal value of firm in year 5 = 16.75/(.12 - .04) = $209.375 million c. Reinvestment rate = 10/20 = 50% (in perpetuity) Return on capital in perpetuity = g/ Reinvestment rate = .04/.5 = 8% b. Terminal value if net cap ex is zero = 33.50/ (.12-.04) = $ 418.75 million c. Return on capital in perpetuity has to be infinite to allow growth rate to be positive while reinvestment rate is zero. Problem 6 a. Expected after-tax operating income in year 4 = 40 (1.07)3 (1.03) = $50.96 Return on capital = 40/ 400 = 10% Reinvestment rate in year 4 = g/ ROC = 3%/10% = 30% Value at end of year 3 = 50.96 (1 - .30)/ (.10 - .03) = $ 509.60 million b. If no growth after year 4 Value at end of year 3 = 50.96 (1- 0)/ (.10 0) = $ 509.60 million c. If expected growth rate is 5% Reinvestment rate = g/ ROC = -5/10 = -50% Value at end of year 3 = 50.96 (1- (-.5))/ (.10 (-.05)) = $ 509.60 million There is a partial liquidation of the firm each year which adds to the cashflows. Since the cost of capital = return on capital, the terminal value is not a function of the expected growth rate. Problem 7 a. Expected after-tax operating income in year 4 = 40 (1.07)3 (1.03) = $50.96 Return on capital = 40/ 400 = 10% Reinvestment rate in year 4 = g/ ROC = 3%/10% = 30% Value at end of year 3 = 50.96 (1 - .30)/ (.08 - .03) = $ 713.44 million

    Dividend Discount Models

    b. If no growth after year 4 Value at end of year 3 = 50.96 (1- 0)/ (.08 0) = $ 637.0 million c. If expected growth rate is 5% Reinvestment rate = g/ ROC = -5/10 = -50% Value at end of year 3 = 50.96 (1- (-.5))/ (.08 (-.05)) = $ 588 million Since the cost of capital < return on capital, higher stable growth rates increase terminal value.

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