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FBE 432 - Midterm ExaminationFBE 432 - Midterm ExaminationPART II - LONGER ANSWERS - WRITE ANSWERS IN SPACE PROVIDED. QUESTIONS ARE EQUALLY WEIGHTED (16 POINTS EACH). SHOW ALL CALCULATIONS AND CIRCLE YOUR ANSWERS IN NUMERICAL PARTS OF QUESTIONS.1. Using the following information for a firm:Next Year Next Year’s Net Income EstimateSales $ 2,000 Sales $2,000Operating costs 1,000 Op. Costs 1,000Depreciation 100 Depreciation 100EBIT $ 900Tax rate 40% Taxes 360Additions to working capital 5% of revenues per year Net Income $ 540Required fixed investments $100 first year, grow at same rate as salesGrowth rate in sales 10% Next Year’s Free Cash Flow (FCF) EstimateNet Income $ 540WACC 20% + Depreciation +100- Fixed Investment -100Average industry P-E multiple 10 Change in working Average assets-to-sales ratio 2.5 capital –100Free Cash Flow $ 440a. Use market comparables to value the firm.Using the industry P-E ratio and net income above, Value = 10 x $540 = $5,400Using average assets-to-sales ratio, Value = 2.5 x $ 2,000 = $5,000b. Use a discounted-cash-flow (DCF) approach to valuing the firm.Using the estimated free cash flow from above and the WACC of 20% and perpetual growth rate of 10%, the FCF based DCF estimate is:Value =Assuming depreciation equals fixed investments and investments in working capital grows at the same rate as sales in the future.c. Discuss the range of values for the firm and why they are different.The estimated value ranges from a low of $4,400 using DCF methods to a high of $5,400 using a market comparable P-E valuation. The DCF method uses firm-specific assumptions based on firm-specific analysis and produces a lower value because it accounts for cash outflows on fixed and working capital investments. The asset-to-sales ratio does not look at the cost structure of the firm.d. Discuss the advantages and disadvantages of using market comparables versus discounted cash flow (DCF) to value a given firm.Market comparables are easy to calculate and provide useful benchmarks in assessing DCF-based valuation methods. Market comparables assume that industry averages are equivalent to the firm to be evaluated. There can be substantial differences due to products sold, cost structure, required future investments, capital structure, and the nature of future opportunities. The quality of management is also significant in influencing all of these factors. DCF methods use assumptions specific to the firm and its operating environment that can, if done carefully, identify crucial departures of the firm’s future performance from the market average firms’ performance and the implications of these differences on appropriate valuation.FBE 432 - Midterm Examination (Longer Answers, continued)2. Discuss the venture leasing industry, being sure to address the following issues: (a) the target market for venture leasing and benefits to firms using venture leasing as a source of funds; (b) innovations in venture leasing, including “financial leases for intellectual property” (FLIPS), and the advantages of this type of lease for firms raising funds; (c) risks facing venture-leasing firms and the structure of typical deals in that business; and (d) expected returned demanded by venture leasors and the structure of firms providing financing in this form.a. The standard target market for venture leasing (VL) investments consists of start-up or intermediate-stage firms with requirements for equipment that can be readily valued and redeployed if returned. The biotech, communciations, and computer industies are typical prospects for VL investors satisfying these requirements. Firms using VL financing gain relatively inexpensive access to credit and of course meet their equipment needs without surrendering large amounts of control in the form of dilution of equity.b. A major innovation of VL firms expands the target market to include firms that have valuable intellectual property (IP), like patents or copyrights, that are often produced in high-tech or research–oriented firms. Since IP is carried on the start-up firm’s books at cost, it is often undervalued and VL leases can allow the write-up in these asset values to more properly reflect the firm’s balance sheet without surrendering control to outside equity investors.c. Risks facing VL firms in either traditional or IP deals is realizing a rate of return satisfactory to investors given the risk of start-up firm failures or even low performance and the possible difficulties in realizing value from leased assets recovered in the case of failures. Leases against marketable equipment can reduce the downside risks since equipment can be released or sold at the end of the lease period fairly easily. Ideally, IP properties will also have value to other firms in the market, but the value of IP is much harder to estimate and many patents or copyrights provide only possible protection against use of ideas or technologies. For all these reasons, VL deals typically are smaller than venture capital investments, have relatively short full-payout lease terms (typically 3 to 5 years), and include warrants to offer some upside potential. To achieve targeted rates of returns, a substantial fraction of lease deals must have warrants proving to be valuable in the future.d. VLs typically expect very high returns, in the range of 25% to 50%, to compensate them for the risks of failure or poor or mediocre performance in many of their investments. VL firms are managed by general partners, like Aberlyn Investments, and raise money from investors like wealthy individuals and institutional investors. Some VLs are affiliated with multinational financial firms because of synergies with other financial services and funding and contact with foreign investors attracted to VL because of foreign tax treament.FBE 432 - Midterm ExaminationMarch 8, 2001Name______________________________________ Student No.__________________PART I - MULTIPLE CHOICE - WRITE YOUR NAME AND MARK BEST ANSWERS ON SCANTRON. THERE ARE 17 MULTIPLE CHOICE QUESTIONS TOTAL (4 POINTS EACH).1. Sell side analysts typically work fora. mutual funds.b. institutional investors.c. investment bankers and brokers.d. insurance companies.e. all of the above.2. Continuing value in a valuation context represents the present value of cash flows aftera. the first period.b. the end of the forecast period.c. infinity.d. 10 years.e. the period when discounting makes present values so


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