Corporate Finance, Autumn 2016

Tutorial 7 Company Valuation

Question 1:
Giannetti&C is an Italian chain selling top-quality Italian coffee. Francesca Giannetti, the CEO,
is investigating the option of doing an IPO on the Milan Stock Exchange. She claims her
company will yield a dividend of 500,000 euros to equity holders next year and it is expected to
grow in the future. Francesca is trying to convince investment bankers to propose an IPO price
of 30 euros and to issue 150,000 shares. Graces Coffee, a similar chain selling even superior
coffee, is already trading at Piazza Affari1 and has a return on equity of 15% and a similar
leverage (Debt/Assets) to Giannetti&C.
(a)

FCF1
VALUATION
COST OF
EQUITY
growth rate

=
=

500,000
4,500,000

=
=

15%
3.9%

(b) As it turns out, the dividend growth rate assumed by Francesca Giannetti is unrealistic; a
more realistic estimate is set at 1.5%. What dividend must Giannetti&C guarantee next year to
justify the same IPO price?

FCF1
VALUATION
COST OF
EQUITY
growth rate

=
=

607,500
4,500,000

=
=

15%
1.5%

Question 2:
TerminalV plc is a company producing computer terminals (e.g. printers). Its operating free
cash flows for the next five years are expected to be as follows:
Year
Operating FCF ($M)

1
20

2
70

3
130

4
160

5
180

From year 5 onwards the company is expected to growth at the GDP rate. The company has
debt of $500M and the market value of the equity is $2,000M.
(a) If the opportunity cost of capital for the assets (ie WACC) is 8% what is the implied GDP
growth rate?

Year
Operating FCF
($)
EQUITY VALUE
DEBT

20,000,000 70,000,000
2,000,000,
000
500,000,00

3
130,000,
000

4
5
160,000, 180,000,0
000
00

1 Piazza Affari is the name of the Milan Stock Exchange in Italian business
jargon. It is actually the address of the exchange and it means Business Square
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Corporate Finance, Autumn 2016

FIRM'S VALUE
WACC
DCF 1-4
SUM DCF 1-5
TV 5
FIRM'S VALUE
- SUM DCF 1-5
(1+WACC)^5
(FIRM'S VALUE
- SUM DCF 15)*(1+WACC)
^5
g

0
2,500,000,
000
8%
18,518,519 60,013,717
421,840,17
9
180,000,00
0
*
2,078,159,
821
=
1.5

=
=

103,198,
191

117,604,
776

122,504,9
75

(1+g)

3,053,498,
573
2.0%

(b) If the cost of equity is 9%, what is the interest rate TerminalV is paying on its debt?

Equity/Capital (%)
Debt/Capital (%)
COST OF EQUITY
WACC
COST OF DEBT

0.8
0.2
9%
8%
4%

Question 3:
Below are some financial data related to a group of companies operating in the cosmetics
industry:
Company

Market Cap ($M)

Company A
Company B
Company C

7.100
7.875
20.400

Share Outstanding
(#)
100,000
125,000
200,000

Earnings per Share

($)
10
7.5
12.3

J. Tyler Inc. is expected to report earnings for $1.25M (one year from now) and is trading at
$120/share with 110,000 shares outstanding.
(a) Based exclusively on the information available, is J. Tyler Inc. likely to be trading at a
premium or a discount?
The stock seems to be overvalued based on P/E multiples relative even to the competitor with
higher earnings and bigger marcap, thus, most likely, itll trade at a discount.
Company

Market
Cap ($M)

Shares
outstandin

2 out of 3

EPS
($)

EARNING
S

P/E

Corporate Finance, Autumn 2016

g (#)

Company A
Company B
Company C
AVERAGE PEERS
J. Tyler Inc.

7,100,000
7,875,000
20,400,000
11,791,66
7
13,200,000

100,000
125,000
200,000

10.0
7.5
12.3

141,667

9.9

110,000

11.4

1,000,000
937,500
2,460,000
1,465,83
3
1,250,000

7.1
8.4
8.3
7.9

10.6

(b) The equity cost of capital for J. Tylers peer group is 15%. The company has decided to pay
dividends of 30% of total earnings for the foreseeable future. At what percentage must J. Tyler
Inc earnings grow in order to justify a share price of $120/share?
375,000
13,200,000

Dividend
FIRM'S VALUE
Cost of equity
g

15%
12%

Question 4:
Consider the stock of Kraner Inc., ticker symbol KRNR. The dividends of KRNR are
growing at 6% a year. The current risk-free rate is 5%. The price-dividend ratio is
P0/D0 = 20.
(a) What is KRNR's expected return?

(1+g)
D0/P0
r

1.06
0.05
11%

(b) If the CAPM holds and the market risk premium is 7% per year, what is the market beta of
KRNR?

0.86

(c) If the risk-free rate were 4%, how would the answer to part (b) change?

1.00

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