Topic: TO EQUITY (FCFE) MODEL WEEK4 LEVEL 2 EVA QUESTIONS

1. A manufacturing company is expected to have before-tax cash flow from operations of N750,000 in the coming year. The firm's corporate tax rate is 40%. It is expected that N250,000 of operating cash flow will be invested in new fixed assets. Depreciation for the year will be N125,000. After the coming year, cash flows are expected to grow at 7% per year. The appropriate market capitalization rate for unleveraged cash flow is 13% per year. The firm has no outstanding debt. What is the projected free cash flow of the company for the coming year? A. N250,000 B. N180,000 C. N300,000 D. N380,000

2. What is (MVA)? It is: A. Net operating profit after taxes less capital charge. B. Free cash flow to the firm adjusted for abnormal earnings. C. Free cash flow to equity. D. It is the present value of all future (EVAs).

3. What is market value added (MVA)? It is: A. Net operating profit after taxes less capital charge. B. Free cash flow to the firm adjusted for abnormal earnings. C. Free cash flow to equity. D. It is the present value of all future economic value added (EVAs).

4.Cash flow return on investment (CFROI) differs from economic value added in that CFROI: A. Uses net cash flow rather than gross cash flow. B. Uses net investment rather than gross investment. C. Does not include non-depreciating assets. D. Is a rate of return rather than an absolute Naira amount

5.Given the information below, compute the Economic Value Added of CBA Limited: Net operating profit after tax: N100 Beginning book value of debt: N200 Beginning book value of equity: N300 WACC: 11% A. N45 B. N67 C. N78 D. N95

6 A portfolio manager is currently evaluating the attractiveness of ABC shares. In particular, ABC Ltd. is expected to generate free cash flows of N1.75 in year one, N2.50 in year two, and N3.50 in year three. If the required rate of return on this is 13% and the manager strongly believes that these shares could be sold at a multiple of 14 times the estimated free cash flow at the end of year three, what

would be a fair price for these shares today? A. N33.96 B. N54.93 C. N39.89 D. N35.98

7. A firm has the following per share values: Cash flow from operation (CFO) = N49.50 Capital expenditure = N40 Net borrowing = N7.50 What is the current per share free cash flow to equity (FCFF)? A. N17.00 B. N97.00 C. N16.50 D. N25.00

8. Which of the following is the most appropriate reason for using a free-cash-flowto- equity (FCFE) model to value equity of a company? A. FCFE is a measure of the firm’s paying capacity. B. FCFE models provide more accurate than the dividend discount models. C. A firm’s borrowing activities could influence dividend decisions but they would not impact FCFE. D. None of the above.

What do you understand by Economic Value Added (EVA)? Briefly explain its use in the valuation of equities.

PolyExperts Limited is a successful manufacturer of rubber products in Eastern Nigeria. Since the Initial (IPO), that took place one year ago, the increase in stock price has been impressive. Growth was fostered by an intensive program of investments aimed at extending its international network thereby tapping foreign markets. So far the company has been all-equity financed and the internally generated funds were large enough to finance all new projects. At the end of 2011, PolyExperts is planning to undertake the acquisition of a company that maintains vast rubber plantations across the country. A consultant working with the company in its expansion plans would like to evaluate PolyExperts. The following tables show the income statements of PolyExperts, the planned capital expenditures ("CAPEX") (net of disposals) and the net working capital ("NWC").

Table 1. PolyExperts actual and projected income statements (in millions of Naira).

2011A 2012E 2013E 2014E Sales 400 450 550 670 Cost of sales -190 -200 -240 -290 Advertising -30 -35 -40 -55 Selling costs -20 -20 -30 -30 Administrative expenses -60 -70 -80 -90 EBITDA 100 125 160 205

Depreciation -20 -20 -25 -30 EBIT 80 105 135 175 Taxes -24 -31.5 -40.5 -52.5 56 73.5 94.5 122.5

(b) Calculate the of PolyExperts. Assume a tax rate of 30%.

(c) Assume that the free cash flow of PolyExperts would grow at the rate of 2% into perpetuity after 2014, and that there are 100 million shares outstanding. (c1) Determine the value of the company. (c2) Calculate the price per share.

Question 3 – ‘A negative Economic Value Added (EVA) for the year implies that the firm has not earned enough during the year to cover its cost of capital, and the value of the firm has declined’. Do you agree with this statement? Briefly justify.