Question

101)

Suppose that you are valuing a South African diamond producer that sells most of its products in China, records its sales in Chinese RMB, and has most of its employees in China. The company is publicly traded on the South African stock market. Which of the following should be components of your Cost of Equity calculation for this company?

a) Use Chinese government bond yields for the Risk-Free Rate.

b) Use South African government bond yields for the Risk-Free Rate.

c) The Equity Risk Premium should be based on US stock market historical returns, plus a spread to account for the additional risk and potential returns in South Africa (as the company is listed on the South African stock market).

d) The Equity Risk Premium should be based on US stock market historical returns, plus a spread to account for the additional risk and potential returns in China (as the company operates largely in China).

e) Ideally, Levered Beta should be based on comparable diamond producers that operate in China.

f) Ideally, Levered Beta should be based on comparable diamond producers that are headquartered in South Africa but operate largely in China.

102)

Which of the following represent DIFFERENCES in a Levered DCF analysis compared to an Unlevered DCF analysis?

a) You will calculate Terminal Value using an Equity Value-based multiple rather than an Enterprise Value-based one.

b) You will use Levered Beta rather than Unlevered Beta in the Cost of Equity calculations.

c) You will use Cost of Equity instead of WACC for the discount rate.

d) You don’t have to add back non-cash charges in the same way because Levered Free Cash Flow starts with Net Income rather than NOPAT.

e) You will calculate the company’s Implied Equity Value directly from the analysis, rather than calculating the implied Enterprise Value and then backing into the implied Equity Value.

f) When calculating Free Cash Flow, you have to subtract the net interest expense and mandatory debt repayments.

106)

Which of the following events might serve as catalysts if you are drafting a stock pitch for a healthcare company?

a) The launch of new products in any year of the projection period shown in your DCF analysis.

b) The launch of new pipeline drugs in the next 6-12 months.

c) A debt, equity, or convertible issuance within the next year.

d) A key patent expiration in 2-3 years.

e) An annual price increase that the company announces in January each year.

f) US or EU regulators approving a key drug for sale within the next year.

g) An acquisition that is set to close in 18 months.

Answer 1

(1)Cost of Equity=Risk Free Rate of Return+Beta(Market Rate of Return-Risk Free Rate of Return)

So.component of Cost of equity would be:-

(b)Use South African Government Bond Yield For Risk Free rate =Because as comany is Traded in South African Market there investor would expect Risk Free Return of South african market.

(d)The Equity Risk Premium Should be Based on US market Historical Returns,plus a spread to account for addditional risk and Potential Return in China=Because Company Sales is Largely in China it affected by risk of China Market.

(f)Leverage Beta Should Be Based on Comparble Diamond Producers that are headquarters in South africa but largely operates in china=Because beta is taken of comapny who operates at same level of risk.

(2).Differences between leverage DCF Analysis as compared to Unlivered DCF Analysis:-

(c)You Will Cost of Equity Instead of WACC For the Discount Rate=In Unlivered DCF Analysis we are determining Cash Flows Avaiable for to the Entire Capital Structure so we use weighted average cost of capital.In livered Free Cash Flow we are Determing Cash Flow Available to Equity Investors so we use cost of equity(or CAPM).

(b).You will use livered beta in Cost of Equity Instead of unlivered Beta.