Birla Institute of Technology & Science, Pilani, Hyderabad Campus,

First Semester 2024-25

ID: Name:
Course No. ECON F355 Course Title: Business Analysis & Valuation
Comprehensive Examination Marks: 80 (60+20) Weightage 40%
Date: 01/12/2024, 9:00am-12:30pm, FN
This is the CLOSED book section of the examination. Scientific calculators are allowed. There are
5 questions in this Part A. Answers written in the space mentioned will only be considered for
evaluation. Please write all steps showing all calculations. This part has 10 pages. Mobile phones
and other electronics are not allowed. The total marks for part A is 60 marks. Maximum time allotted
for this part A is 2 hours 15 minutes. Please ensure you have written your name and ID number.

PART A [60 Marks]

Question 1. [10 MARKS]

MVP, Inc., has produced rodeo supplies for over 20 years. The company currently has a debt-equity
ratio of 50 percent and the tax rate is 40 percent. The required return on the firm's levered equity is 16
percent. The company is planning to expand its production capacity. The equipment to be purchased is
expected to generate the following unlevered cash flows:

Year 0 1 2 3
Cashflow -$18,000,000 5,700,000 9,500,000 8,800,000

The company has arranged a perpetual debt issue of $9.3 million. Under the loan, the company would
pay interest of 9 percent at the end of each year. Calculate the APV of the project.
NOTE: the interest payment in each year is calculated

Write your answer:

Cost of Capital for unlevered firm [2 marks]

NPV of all equity project [4 marks]

NPV of financing side effects [4 marks]

Working below
Question 2. [10 MARKS]
Flatheads Ltd make shoes for the new generation. It revolutionized the casual footwear through
innovative materials and thoughtful design that is relevant to our lifestyle. Flatheads shoes are made
with natural materials like bamboo and banana fibre, optimized to offer comfort that lasts all through
the day and more! From meetings to meet-ups, their shoes are crafted to fit every aesthetic. Flat head
Ltd. is trying to set up a new facility, which requires an initial investment in PPE (Property plant and
equipment) is $40 million. The initial investment in Net Working capital (NWC) is $8 million. The
plant also requires additional investment in capital expenditures (for maintenance of assets which are
not depreciated) and net working capital to the tune of 30% and 10%, respectively, of the predicted
change in sales revenue each year. At the end of its life in year 3, there is no additional capex and no
addition NWC requirement.
The Sales revenue projected for Year 1 is $120 million and is expected to grow at 10% per
annum. The facility can be operational for 3 years and the salvage value of working capital and Net
PPE can be taken as the book value prevailing at the end of the project. The target debt-to-assets ratio
is 30% and the cost of borrowing is 9%. The gross profit margin is 35% and the operating expenses
(excluding depreciation) are 15% of sales revenue for the given years. The tax authorities allow a
declining balance method of depreciation, where depreciation in each period is 25% of the book value
of the asset at the beginning of the period. The prior period Net PPE (i.e. Net PPE at t= 0) was 75% of
initial investment in PPE. The corporate tax rate is 30%.
(Note: Investments in CAPEXt and change in NWCt is a % of change in Sales revenuet+1 for t=1 to 2).

2.1. [2 marks] Project the Income statement for the project (Year 1- Year 3)

2.2. [2 marks] Project the balance sheet for the project (Year 0 – Year 3)

2.3. [2 marks] Project the FCFE (Free Cash flow to equity) for the project. (Year 0 –Year 3)

2.4. [2 marks] If the risk-free rate is 6% p.a. and the market risk premium is 5% p.a., the beta of the
project is 1.5, what is the cost of equity capital for the project?

2.5 [2 marks] What is the NPV of the project using the Flow to equity method?
Write you answer:
Year 0 1 2 3

2.1.Net income

2.2. Total Assets

2.3. FCFE

2.4. Cost of Equity

2.5. NPV

Working below
Question 3. [10 marks]
Maharaja Appliances is considering building a new factory at a cost of $180,000. This
factory is expected to produce cash flows of $24,000 per year for 25 years starting a year from
today. Within 2 years, if the product is a success, then the plant could be expanded at a cost of
$125,000. The expected cash flows from this expansion would be $13,000 per year for 23 years
with the 1st cash flow coming 1 year after the expansion is complete (i.e. 3 years from today).
The standard deviation of returns on the expansion is 27% per annum. The return on treasury
bill is 5% per annum continuously compounded. The required return on this factory and the
possible expansion is 9.5% per year (EAR). Using the Black-Scholes Option Pricing Model to
value the expansion option, should the factory be built?

Write your Answer:

NPV without the option to expand

NPV with the option to expand

Comment whether or not the option to expand is adding

value?

Working below
Question 4. [10 marks]
Jasprit Kamra is considering whether to acquire a local toy manufacturing company, Toys 'n' Things
Inc. The company's annual income statements for three years are as follows:

2024 2023 2022

Revenues $2,243,155 $2,001,501 $2,115,002

Cost of Good Sold $1,458,051 $1,300,976 $1,374,751

Gross Profits $785,104 $700,525 $740,251

General and Administrative expenses 574,316 550,150 561,500

Net Operating Income 210,789 150,375 178,751

4.1. [4 Marks] Jasprit has learned that small private companies such as this one typically sell for
EBITDA multiples of three to four times. Depreciation expense equals $50,000 per year. What value
would you recommend Jasprit put on the company?
4.2. [4 marks] The current owner of Toys'n' Things indicated to Jasprit that he would not take less than
five times 2024 EBITDA to sell out. Jasprit decides that, based on what he knows about the company,
the price could not be justified. However, upon further investigation, Jasprit learns that the owner's wife
is paid $100,000 a year for administrative services that Jasprit thinks could be done by a $50,000-per-
year assistant. Moreover, the owner pays himself a salary of $250,000 per year to run the business,
which Jasprit thinks is at least $50,000 too high based on the demands of the business. In addition,
Jasprit thinks that, by outsourcing raw materials from China, he can reduce the firm's cost of goods sold
by 10%. After making adjustments for excessive salaries, what value should Jasprit place on the
business?
4.3. [2 mark] Can Jasprit justify the value the owner is placing on the business?
Write your Answer
4.1.Value of Toys 'n' Things

4.2.Value of the Toys 'n' Things after adjustments

4.3.Can Jasprit justify the value placed by the owner? (YES/NO)

Working Below
FORMULAS
PV of a perpetuity = C/r, where r is not equal to 0.
PV of a growing perpetuity = C/(r-g), where r>g
PV of an Annuity = (C/r) * [1-(1/(1+r)^t)]
PV of a Growing Annuity = (C/(r-g)) *[1-((1+g)/(1+r))^t]
FCFF = EBIT*(1-Tax rate) + DA – CAPEX – Change in Operating Net WC
FCFE = (EBIT – I)*(1-Tax rate) + DA – CAPEX – Change in Operating Net WC +Net Proceeds to
debt-Principal payments on debt-Preferred dividend
βL = βu + ((βu – βd) D (1 – Tax rate) / E)
Rs = Rf + β*(Rm –Rf)
Rs = R0 + D*(1-Tax rate) (R0-Rb)/E
σ2
ln(S / E ) + (r + )T
2
C0 = S  N(d1 ) − Ee − rT  N(d 2 ) ; d1 =  T ; d 2 = d1 −  T
QUESTION 5. CROSSWORD [20 marks]
Note: Only words correctly filled in the CROSSWORD will be awarded marks. Each word carries one mark. No marks will be awarded for
spelling mistakes.
 Down
Across 1. In BCG matrix, the… ...............category represents
products and services with high market growth but low
3. For an unlevered firm, the free cash flow to the firm
market share. (No space)
is… ......................... to the free cash flow to equity.
2. The minimum acceptable rate of return on a capital
6. The valuation method to be used if the capital
investment project is called .......................... rate.
structure is changing is called ------------------------ present
value method. 3. Earnings criterion implicitly uses the wrong cost of
8 .......................... cash
flows that are considered relevant capital to evaluate an investment. We refer to this as
to the valuation of a project, being only those that are a the……………. problem. (includes hyphen)
direct result of the acceptance of an 4 ............................... represent a business acquisition
investment? strategy whereby an investor group acquires all the equity
10. If the cash flows in the valuation exercise for a of a firm and assumes its debts. (it is an abbreviation)
levered firm is FCFF, the discount rate should be the cost 5. For an unlevered firm, The free cash flow to the firm
of………………….. is… ................................... to the free cash flow to
13. Private equity investments are ........................ and equity.
illiquid and thus require high returns. 7. In….................... equivalent method of valuation, the
15. Porter’s five forces model evaluates the cash flows are adjusted for risk.
profitability of any ……………. 9................................... synergies
occur when the
combined company can increase its sales by
16. Stern ------------------------ and Company developed
accessing new capital or leveraging its expanded customer
EVA (Economic Profit) to provide a single, value-
base.
based measure which can be used in solving the
measurement problem in short-term. 11. An investment project that reduces the firm’s earnings
17................................valuation refers to the value of in the current or following year is referred to as
the startup business that is implied by the amount of money earnings………….
invested by the VC fund in combination with the fraction 12. If Discounted Cash Flow (DCF) valuation is
of the startup company’s shares that the VC acquires. employed to assess the worth of a firm's cash flows during
(includes hypen). the planning period, while relative valuation is utilized for
19........................................ depreciation is simply the calculating terminal value, it is called as ………………
change in the present value of a project’s expected future valuation approach.
cashflows from year to year. 14. An option to …………………. provides a company with
the flexibility to increase the scale of a project in the future
when the initial project is performing well.
18. Private equity firms, while valuing the Young firms
and startups that do not have an established history of
earnings use the ratio of Enterprise Value (EV)
to……………….