Question

7 part a

Year                                      1                              2                              3                             4                              5

Free Cash Flow      $22 million          $26 million          $29 million          $30 million          $32 million

General Industries is expected to generate the above free cash flows over the next five years, after which free cash flows are expected to grow at a rate of 5% per year. If the weighted average cost of capital is 9% and General Industries has cash of $15 million, debt of $45 million, and 80 million shares outstanding, what is General Industries' expected current share price?

	a.	$6.19
	b.	$8.17
	c.	$7.78
	d.	$11.57

part b 10:

Year 0	Years 1 to 10
Revenues		2.90
- Manufacturing Expenses		-0.5
- Marketing Expenses		-0.15
- Depreciation		- 0.5
= EBIT		1.75
- Taxes (40%)		-0.70
= Unlevered net income		1.05
+ Depreciation		+0.5
- Additions to Net Working Capital		-0.4
- Capital Expenditures	-6.00
= Free Cash Flow		1.15

Panjandrum Industries, a manufacturer of industrial piping, is evaluating whether it should expand into the sale of plastic fittings for home garden sprinkler systems. It has made the above estimates of free cash flows resulting from such a decision. There are concerns of the sensitivity of this project to changes in the cost of capital. For what cost of capital does this project break-even? (Hint...Remember what IRR does!)

	a.	8%
	b.	10%
	c.	12%
	d.	14%

part c 11:

the average annual return for the S&P 500 from 1886 to 2006 is 5%, with a standard deviation of 15%. Based on these numbers, what is a 95% confidence interval for 2007's returns?

	a.	-12.5%, 17.5%
	b.	-15%, 25%
	c.	-25%, 35%
	d.	-25%, 25%

Answer 1

Part A

Answer is : c. $7.78

..

Year	1	2	3	4	5
Free Cash Flow	$22 million	26 m	29 m	30 m	32 m

current price per share = value of equity / number of share outstanding

.Value of equity  = value of firm  –  value of debt

Market value today = value of firm = present value of FCF of years 1 to 5 + present value of horizon value

.

Next steps, calculate market value today

.

Market value today = present value of FCF of years 1 to 5 + present value of horizon value

.

present value of FCF of years 1 to 5

Year	FCF	PV of interest factor @ 9%	PV of FCF
1	22	0.917431	20.183482
2	26	0.84168	21.88368
3	29	0.77218	22.39322
4	30	0.708425	21.25275
5	32	0.649931	20.797792
			106.510924

present value of FCF of years 1 to 5 = $106.510924 million

.

Next calculate .Horizon value

Horizon value = ( FCF3 *(1+g) ) / (WACC - g )

.

Where,

Horizon value = It is the value at a specified future time that includes the total of discounted value to be received after that future period. Future time, which is the date the growth rate in cash flow is constant forever.

FCF = free cash flow at year 5 = $32 million

G = Growth rate = 5%

WACC = 9%

Horizon value = ( 32 + ( 1 + 5%) ) / ( 9% - 5% )

Horizon value = 33.6 / 4%

Horizon value = $840 million

present value of horizon value = horizon value * PVIF,9%,5

present value of horizon value = 840 * 0.649931 = 545.94204

.

Firm’s Market value today = $106.512+ 545.94

Firm’s Market value today = $652.50 million

.

Next calculate current price per share

current price per share = value of equity / number of share outstanding

.

Value of equity  = value of firm  –  value of debt

value of firm = $652.50 million

value of debt = $45 million

Value of equity  = $652.50 million - $45 million = $607.5 million

.

Current price per share = $607.45 million / 80 million shares = $7.60per share

.

Answer is : c. $7.78

.

Different is occurring from round off

.

.

Part B

.

Answer: d. 14%

.

The project will have break even when it has no profit or loss which means NPV of Project become zero. Internal rate of return is a discount rate that makes the NPV be Zero, so,

0 = NPV = PV of FCF - initial investment

.

Those discount rate is the cost of capital does this project break-even.

.

Initial investment = -6

FCF 1^st year to 10^th year = 1.15

.

0 = 1.15 * PVIFA

…

PVIFA = present value of interest factor annuity discounted at IRR, for 10 year

.

It can be solve using PV of Annuity Table

.

PVIFA,irr,10 = 6 / 1.15 = 5.21739

.

Next go through the PV of annuity table, 10 year period row, and find the closest value of 5.21739, and after look at top of that column, and find the interest rat.

* This interest rate is the IRR of this project to become break-even

The closest value in table is = 5.2161, and its interest rate = 14%

So,

Appro, IRR = 14%

.

In the options, option D is the correct answer

.

Answer: d. 14%

.

.

Part C

.

Correct answer is option c.   -25%, 35%

.

the average annual return for the S&P 500 from 1886 to 2006 is 5%, with a standard deviation of 15%. Based on these numbers, what is a 95% confidence interval for 2007's returns?

.

Based on the 68-95-99 rule,

.

Approx. 95% of the data falls within 2 standard deviations of the mean (or between the mean – 2 times the SD, and the mean + 2 times the SD). The mathematical notation for this is: μ ± 2σ

.

Calculation of 95% Confidence Interval for 2007’s return

.

Based on this,

.

Return interval = Average Return% +/- 2 * Standard deviation

.

Return interval = 5% +/- 2 * 15%

.

Lower interval = 5% - 30% = -25%

Higher interval = 5% + 30% = 35%

..

Correct answer is option c.   -25%, 35%