Problem 1.

(9 points in total)

BigBooks is a listed firm publishing mostly novels. You are given the following data on
BigBooks:
Book value of equity 120
Book value of financial debt 200
Book value of accounts payables 20
Book value of excess cash 50
Stock price of BigBooks 1
Number of shares of BigBooks 250
Equity beta of BigBooks 1.2
Credit rating of BigBooks BBB

You are also given the following financial data:

Equity market risk premium 5%
Yield on 1-year US Treasury 0.5%
Yield on 10-year US Treasury 1.5%
Yield on 20-year US Treasury 2%
Yield on 1-year BBB bonds 1.5%
Yield on 10-year BBB bonds 3%
Yield on 20-year BBB bonds 4.5%

The corporate tax rate is 25%.

Question 1. What is the WACC of BigBooks, given that its cost of debt is 2.5%? [Input
your response in percentage, with one decimal, but without the “percent” sign. Round to
the nearest decimal. For example, if the answer is “2.257%”, enter “2.3”.] (2 points)

D = 200 – 50 = 150
E = 250
Rd = 2.5%
Re = 2% + 1.2*5% = 8%
WACC = 150/400 * (1-0.25) * 2.5% + 250/400 * 8% = 5,702 %.

Question 2. BigBooks is considering making a series of acquisitions. The first acquisition

they are considering is that of another listed firm, called SmallBooks. SmallBooks is in
the same industry, as it also publishes novels. The WACC of SmallBooks as a standalone
company is 5% and an equity market beta of 1.2. Which WACC should BigBooks use to
value SmallBooks as a standalone company? (1 point)

X The WACC of BigBooks

X The WACC of SmallBooks
X Some intermediate value between the WACC of BigBooks and the WACC of SmallBooks

Question 3. If this acquisition goes through, BigBooks expects some synergies to be

realized. Which of the following statement is true? (1 point)

X The existence of synergies will necessarily lower the WACC of BigBooks (after it completes
the acquisition).
X The existence of synergies will necessarily increase the WACC of BigBooks (after it
completes the acquisition).
X If the beta of the synergies is below 1.2, the WACC of BigBooks will decrease (after it
completes the acquisition).
X If the synergies reduce the volatility of cash flows, the WACC of BigBooks will decrease
(after it completes the acquisition).
X None of the above statements is correct.

Question 4. BigBooks is now considering the acquisition of a private firm, called

SmallScreens, in the technology sector. You want to compute the appropriate WACC to
value SmallScreens, and you are given the following information about its peer firms.

Stock price Number of Financial Accounts Cash Equity

shares debt payables beta
Peer 1 15 10 150 30 10 1,7
Peer 2 20 8 40 0 50 1,5
Peer 3 10 12 100 30 20 1,8

What is the average unlevered beta in the technology sector? Remember that Beta(U) =
Beta(E)/(1+D/E)? Please round at the first decimal. (2 points)

The average unlevered beta is 1.186.

Question 5: What is your estimate of the equity beta of SmallScreens, knowing that its
target leverage is D/(D+E) = 40%? [Input your response in percentage, with one
decimal, but without the “percent” sign. Round to the nearest decimal. For example, if
the answer is “2.257%”, enter “2.3”.] (1 point)

D/E = 40%/60%
Beta(E) = (1+D/E)*Beta(U) = 2

Question 6: What is your estimate of the WACC of SmallScreens, given the financial
data given above? The cost of debt of SmallScreens, given its target leverage, would be
3%. [Input your response in percentage, with one decimal, but without the “percent”
sign. Round to the nearest decimal. For example, if the answer is “2.257%”, enter
“2.3”.] (2 points)

Re = 2% + 2*5% = 12%
WACC = (1-25%)*40%*3% + 60%*12% = 8.1%

Problem 2. (11 points in total).

You are given the following financial information about firm F. The tax rate is 28%.
Year 0 1 2 3
Sales 100 110 121 133,1
COGS 37,9 55 60,5 66,55
SGA 12,3 22 24,2 26,62
Depreciation 2,3 3,4 3,8 4,1
 CAPX 4,1 4,6 5,1 5,6
Inventory 18 19 20 21
A/R 6,6 7 7,5 8
A/P 1,2 2 2,3 2,9

Question 1. What is the EBIT in year 2? Please round at the first decimal. (1 point)

EBIT = 121-60.5-24.2-3.8 = 32.5

Question 2. What is the net working capital in year 1? Please round at the first decimal.
(1 point)

NWC = 19+7-2 = 24

Question 3. What is the free cash flow in year 2? Please round at the first decimal, and
remember that FCF = (1-t)EBIT+Dep − CAPX – DNWC. (1 point)

FCF = 20.9

Question 4. You are being told that FCF in year 3 (which is the last year of the explicit
forecast period) would be 23.4. Assume a WACC of 11% and a perpetual growth rate of
the free cash flows of 1% after year 3. Using a growing perpetuity, what is the value of
the terminal value in year 3 ? Please round at the first decimal. (1 point)

TV = (1+0.01)*23.4 / (11%-1%) = 236.34

Question 5. We are currently at the end of year 0 (that is, free cash flows in year 0 have
already been earned). You are being told that FCF in years 0 and 1 are respectively 32.2
and 19.5. What is he present value of all free cash flows until the end of the explicit
forecast period? Please round at the first decimal. (2 points)

PV(FCF) = 19.5/(1.11) + 20.9/(1.11)^2 + 23.4/(1.11)^3 = 51,639

Question 6. What is the present value of the terminal value? Please round at the first
decimal. (1 point)

PV(TV) = 236.34/(1.11)^3 = 172.809

Question 7. You are being given the following information on the peers of firms F. Use
this information to estimate the terminal value (as of year 3) using the EV/EBITDA
multiple. Please round at the first decimal. (2 points)

Stock Price Shares Debt Cash EBITDA Net

Outstanding Income
Firm A 20 4 20 1 12 2
Firm B 11 2 22 16 5 -1
Firm C 18 2 11 3 8 1
Firm D 17 6 45 10 15 3
The average EV/EBITDA ratio of the four peer firms is 7.12.
The EBITDA of firm F in year 3 is 39,93.
The TV is 39,93*7.12 = 284,3

Question 8. What is the average P/E ratio of the peers of firm? Please round at the first
decimal. (1 point).

Consider only the 3 firms with positive net income. The average P/E ratio is 36.7.

Question 9. Estimate the value of firm F’s stock price using the P/E multiple, and given
that its EPS is equal to 1.2 in year 0. Please round at the first decimal. (1 point)

Stock price = 1.2*36.7 = 44.0

Problem 4. Multiple choice questions (1 point per question – 8 points in total).

Question 1. The beta of a firm’s debt is always lower than its equity beta.
True / False / Unclear.

Question 2. Company A has a price-earnings (P/E) ratio of 12, while other comparable
firms have an average P/E ratio of 9. This implies that the stock of company A is
overpriced.
True / False / Unclear.

Question 3. Imagine a company that is financed with 100% of equity and whose assets
are composed of 100% of cash. The equity beta of this company is equal to 1.
True / False / Unclear.

Question 4. The WACC of a company can never be lower than the risk-free rate.
True / False / Unclear.

Question 5. A cash sweep is an arrangement that specifies that a certain fraction of the
cash flow available must necessarily be used to compensate equityholders.
True / False / Unclear.

Question 6. What we call “consideration” in mergers and acquisitions is the means of

payments that are used by the acquirer.
True / False / Unclear.

Question 7. Company X has a WACC of 13% and generally uses a hurdle rate of 13%
for all its investments in the same industry. It is considering diversification into another
industry and wants to use the IRR to value a potential target with a WACC of 7%.
When applying the IRR method, it should use its usual hurdle rate of 13% to value that
target.
True / False / Unclear.

Question 8. To compute the enterprise value, we must add the market value of equity
with the value of total debt (both financial and operational), and then subtract cash and
cash equivalents.
True / False / Unclear.