Second Examination – Finance 3321

FSA3321 (Moore) Exam 3 Summer 1 - 2005 Third Examination – Finance 3321 Summer 2005 (Moore) – Version 1

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Clearly Circle the BEST response for each of the following questions (Multiple Choice @4):

Use the attached financial statements for Dell-U-Dead Corp. to answer questions 1-3

1. Compute Dell-U-Dead’s current ratio for the year ended February 1, 2002. a. 0.70 b. 0.81 c. 0.95 d. 1.05 e. 1.43

2. Compute Dell-U-Dead’s Days Sales Outstanding for the year ended February 1, 2001. a. 5.74 b. 26.57 c. 27.75 d. 32.27 e. 34.77

3. Compute Dell-U-Dead’s Operating Profit Margin for the year ended February 1, 2002. a. 5.74% b. 8.35% c. 9.31% d. 11.85% e. 11.93%

- 1 - FSA3321 (Moore) Exam 3 Summer 1 - 2005

4. Which of the following decreases free cash flows to the firm (both equity and debt)? a. An increase in gross margins b. An increase in inventories c. A decrease in accounts receivable d. An increase in accounts payable e. A decrease in Plant, Property and Equipment

5. As the firm’s net financial leverage increases: a. Its spread moves in the same direction b. Its spread moves in the opposite direction c. Its spread moves independently d. Its spread changes at the same level since the two terms that mean the same thing e. Its spread is controlled by the product management function

6. Which of the following actions would increase a company’s sustainable growth rate? a. Decreasing Inventory turnover b. Purchasing Fixed Assets c. Decreasing Cost of Goods Sold d. Increasing Accounts Payable Turnover e. Increasing the dividend payout ratio

7. Total Asset Turnover in 2004 is computed at 1.40 on an asset base of 10,000,000. Total sales in 2005 are predicted to grow by 10% and net income is expected to grow by 5%. Assuming Asset Turnover is forecast to be 1.5 in 2005, forecast Total Assets for 2005. a. $9,800,000 b. $10,266,667 c. $10,500,000 d. $11,000,000 e. $15,000,000

8. Which of the following types of businesses do you expect to show the highest degree of seasonality in quarterly earnings? a. Fast Food Restaurants (e.g. McDonalds). b. Supermarkets and Grocery Stores c. Diversified Freight and Transport Companies d. Auto Parts Stores e. Cotton Farming

9. Which of the following situations will most likely result in managers deciding to increase the outlays for working capital? a. they expect that the sales will shrink in the future, b. they expect that operating efficiency will improve c. the way of doing business is not likely to change d. Working Capital Turnover is projected to despite constant forecast sales. e. Days Sales Outstanding is expected to increase despite no change in sales.

10.Consider a following company: VD is 100 with kd of 9%. VE is 200 and WACCBT is 13.0%.

ke is 15% and the tax rate is 30%. Compute the after tax WACC for the firm. a. 6.3% b. 9.1% c. 12.1% d. 13.0% e. 15.4%

11.Consider a company with the following: Value of debt is 200 with kd of 12%. Value of the

firm is 600; ke is 18% and rf = 4% and T = 30%. Compute WACC before tax. a. 4% b. 12% c. 14.8% d. 16% e. 18%

12.Assume the market return and risk-free rate remain unchanged. Which of the following must be true if the firm’s Beta suddenly changes from 1.8 to 0.9? a. The firms cost of equity declines by 50% b. The firm’s cost of debt increases in direct proportion to the decrease in the cost of equity because the WACC must remain constant c. The WACC of the firm decreases d. The value of the equity decreases e. The cost of equity increases

13.You have just computed the Beta of a stock to be 1.5 and the estimate of the relevant risk-

free rate is 3%. The expected market return next period is 6% and your estimate of Ke is 15%. What is the appropriate long-run market risk premium? a. 3.0% b. 7.0% c. 7.5% d. 8.0% e. 9.0%

14.Assume next period’s dividend is forecast to be $1.20 per share; that WACC = .18; the cost of equity is 20%; the cost of debt is 14%; the risk-free rate is 5% and the long-run dividend growth rate is expected to be 4% . The best estimate the today’s share value using the discounted dividends method is: a. $6.00 b. $6.24 c. $7.500 d. $12.00 e. $40.00

- 3 - FSA3321 (Moore) Exam 3 Summer 1 - 2005 15.From an empirical (estimation) perspective, the main problem of the discounted dividends valuation model (as compared to free cash flows and residual income) is that: a. Dividend payments are too variable compared with price variability b. The implied investment horizon to recover value is unrealistically short. c. The amount of price variability explained by dividend variability is relatively small. d. Next period’s dividends are relatively difficult to predict. e. Special dividends are difficult to incorporate when firms pay regular dividends

16.Discounted dividends valuation models require which of the following discount factors? a. WACC and the dividend growth rate b. Cost of Debt and Cost of Equity c. Cost of Debt and the dividend growth rate d. Cost of Equity and the dividend growth rate e. Cost of Equity and WACC

Use the following information to solve the following three (3) problems Valuation with P/E and P/B multiples (finish this)

Atmos Energy is a west Texas based natural gas producer and distributor that you are trying to value. Using the method of comparables, assess the value of Atmos. Information is provided concerning the current share price (PPS), current earnings per share (EPS) and the current book value of equity per share (BPS) for Atmos and three of its competitors.

Required: Value Atmos using the P/E and P/B multiples.

PPS EPS BPS CrossTex Industries 41.75 2.83 28.13 RGC Resources 24.33 1.78 17.82 Atmos Engergy Corp. 25.75 1.55 18.15 Kinder Morgan 63.40 3.11 21.75

17.Using the Price earnings multiple, what is the value per share for Atmos Energy when performing a valuation based on the method of comparables? a. $25.22 b. $25.35 c. $26.00 d. $32.59 e. $34.87

18.Using the Price-to-book multiple, what is the value per share for Atmos Energy when performing a valuation based on the method of comparables? a. $25.22 b. $25.35 c. $32.59 d. $32.82 e. $34.87

19.Which company appears to be an “outlier” that should be omitted when computing the industry average market-to-book ratio? a. CrossTex Industries b. RGC Resources c. Atmos Engergy Corp. d. Kinder Morgan e. None of the firms appear to be an outlier

20.The present value (today) of the terminal (continuation) value cash flow that begins in 7 years is $157,542,407 assuming a cost of equity equal to 8%. The year 7 free cash flow (beginning of the growing perpetuity) is $15,000,000. What is the growth rate required for the continuation value term? a. 1% b. 2% c. 3% d. 4% e. 5%

Computation of Valuations Models Section Use the following summary financial statement information and forecasts provided by TTU Value-Metrics to answer the valuation questions in this section about Hi-Flyer Corp.

Actual Estimated Estimated Estimated All Per Share 31 Dec 2004 31 Dec 2005 31 Dec 2006 31 Dec 2007 EPS 4.50 5.25 3.60 4.80 DPS 1.10 1.50 1.80 2.00 BVE (year end) 25.00 CFFO 5.00 6.00 4.00 6.00 CFFI -3.00 -2.50 -4.00 -5.00 CFFF -2.00 -4.00 2.00 2.00 BV Liabilities 25.00 Ke 0.08 Kd 0.06 WACC 0.07 CFFO = Cash Flow from operating activities CFFI = Cash Flow from investing activities CFFF = Cash Flow from financing activities

21.Using the TTU Value-Metrics forecasts, determine the intrinsic value of High Flyer shares. Use the discounted dividends model; assume the forecast dividend payment in 2008 is $2.25 and that is will growth by 4% per year in perpetuity. The intrinsic share value is: a. $29.95 b. $37.50 c. $41.85 d. $49.17 e. $60.77

22.(Sensitivity Analysis). You know that dividend growth rates are estimated with error. In the previous problem, the dividend growth perpetuity was assumed to be 4% per year. What would be the impact on share price if the growth rate were assumed to be 2% (all other information remains the same). a. $14.88 higher b. $14.88 lower c. $18.75 higher d. $18.75 lower e. cannot be determined from the information provided

23.(Free Cash Flow Valuation). Compute the free cash flow per share to the firm in 2007. a. $6.00 b. $0.75 c. $1.00 d. $7.50 e. $10.00

24.(Free Cash Flow Valuation). Assume that free cash flow per share to the firm per share is forecast to be $2.00 per share in 2008 and that it is expected to grow by 6% per year thereafter. The estimated intrinsic value per share is: a. 78.13 b. 103.93 c. $3.93 d. $142.35 e. $75.13

25.What would the impact on your estimated share price be in the previous question if the growth rate in the terminal value perpetuity were zero? a. $171.43 increase b. $171.43 decrease c. $139.94 increase d. $139.94 decrease e. $18.78 decrease

- 6 - FSA3321 (Moore) Exam 3 Summer 1 - 2005 Dell-U-Dead Computer Corporation Balance Sheet (in Millions) (1 February 20XX)

ASSETS 2002 2001 Current Assets: Cash and equivalents $ 3,641 $ 4,910 Short-term Investments 273 525 Accounts Receivable (net) 2,269 2,424 Inventories 278 400 Other 1,419 1,467 Total Current Assets $ 7,877 $ 9,726 Non-Current Assets: Property, plant and equipment (net) 826 996 Investments 4,373 2,418 Goodwill 359 290 Other non-current assets 100 240 Total non-current assets $ 5,658 $ 3,499 Total Assets $13,535 $13,670 LIABILITIES AND STOCKHOLDERS’ EQUITY Current Liabilities: Accounts Payable $ 5,075 $ 4,286 Accrued Liabilities 1,600 1,550 Unearned Revenues 444 192 Notes Payable – Current 300 450 Other 100 300 Total Current Liabilities $ 7,519 $ 6,778 Non-Current Liabilities: Long-Term Debt 520 509 Pension Liabilities 302 261 Other Post-Retirement Benefit Liabilities 150 120 Deferred Tax Liability 120 100 Other Liabilities 230 280 Total Non-Current Liabilities $ 1,322 $ 1,270 Total Liabilities $ 8,841 $ 8,048 Stockholders’ Equity: Common Stock Issued and Outstanding $ 5,605 $ 4,795 Treasury Stock (2,249) --- Retained Earnings 1,364 839 Other Comprehensive Income ( 26) (12) Total Stockholders’ Equity $ 4,694 $ 5,622 Total Liabilities & Stockholders’ Equity $13,535 $13,670

Dell-U-Dead Computer Corporation Income Statement (in Millions**) For the Year Ending February 1, 20XX)=

2002 2001 Net Revenue $31,168 $31,888 Less: Cost of Goods Sold 25,661 25,445 Gross Profit $ 5,507 $ 6,433 Operating Expenses Selling, General and Administrative $ 1,824 $ 2,333 Interest Expense 76 67 Lease Expenses 884 793 Research, Development and Engineering 452 482 Special charges 482 105 Total operating expenses $ 3,718 $ 3,780 Operating Income $ 1,789 $ 2,663 Investment and other income (loss), net of tax (58) 581 Income before taxes and cumulative effect of change in accounting principle $ 1,731 $ 3,194 Provision for income taxes 485 958 Income before cumulative effect of change in accounting principle $ 1,246 $ 2,236 Cumulative effect of change in accounting principle --- 59 Net Income $ 1,246 $ 2,177

Earnings Per Common Share: Basic EPS $ 0.48 $ 0.87 Diluted EPS $ 0.26 $ 0.79

Weighted Average Shares Outstanding: Basic 2,602 2,582 Diluted 4,543 2,746

** All items in millions of dollars except Earnings per Share data

Dell-U-Dead Computer Corporation Statement of Cash Flows (in Millions) For the Year Ending February 1, 20XX

2002 2001 Cash Flows from Operating Activities: Net Income $ 1,246 $ 2,177 Adjustment to reconcile income to cash provided by operating activities: Depreciation and amortization 239 240 Tax benefits of employee stock plans 487 929 Special charges 742 105 Gains/Losses in investments 17 (307) Other 178 135 Changes in: Operating working capital 826 642 Non-current assets and liabilities 62 274 Net cash provided by operating activities $ 3,797 $ 4,195 Cash Flows from investing activities: Investments in securities: Purchases $(5,382) $(2,606) Maturities and sales 3,425 2,331 Capital expenditures (303) (482) Net cash used in investing activities $(2,260) $ (757) Cash flows from financing activities: Purchase of common stock $(3,000) $(2,700) Issuance of common stock under employee plans 295 404 Other 3 (9) Net cash used in financing activities $(2,702) $(2,305) Effect of foreign exchange rates on cash (104) (32) Net increase (decrease) in cash $(1,269) $ 1,101