Question One
“Equity analysts focus far too much on near term earnings to value shares”. Use your knowledge of corporate valuation to critique this statement explaining why it is/is not true. Support your arguments with appropriate academic evidence. (Total: 40 Marks)
Question Two
Answer all parts Show all your workings
(a) Orinoco Corp. is a well-known branded company. You are attempting to value the Orinoco brand. The Company recently reported year end results as follows (in $ millions):
Orinoco has 450 million shares outstanding and is currently trading for $84.00 per share.
You assume that Orinoco will have a 7 year high growth period during which its reinvestment rate (expressed as a percentage of EBIT(1-t)) is expected to be 65.0%. When stable growth is reached, reflecting its highly branded status, Orinoco is assumed to be able to maintain a competitive moat (i.e., a return on excess of its cost of capital) of 2.0%. Stable growth rate is assumed to be 3.5%
Orinoco’s cost of equity is assumed to be 9.6% and its cost of debt (pre-tax) is assumed to be 5.5%. Orinoco’s tax rate is 35%.
What is the value of the Orinoco brand using the All Excess Returns method? (18 marks)
(b) You have also gathered the following recently reported year end information (in $ millions) about Basix Inc., a suitable generic competitor with 90 million shares outstanding and currently trading for $26 per share:
Use market multiples to estimate a brand valuation range for Orinoco. State any assumptions. (12 marks)
(Total: 30 Marks)
Question Three
Johansen, CFA, is planning to initiate coverage on Mohawk Inc., a company competing in a stable growth industry and which recently reported a book value (BV TTM) per share of $19.39 and is expected to report earnings per share of $2.02 next year (EPS1).
She has gathered the following comparable (comp) group information to value the Company using market multiples.
The risk-free rate is estimated at 2.5% and the market risk premium is 6.0%.
(i) Calculate the intrinsic P/E multiples of each firm in the comp group and explain which firms, in your opinion, should be removed from the comp. group. State any assumptions. (14 marks)
(ii) Having reduced the number of firms in your comp group (per (i) above), calculate the market P/E and M/B multiples and use both to suggest a price target and rating for Mohawk. (6 marks)
(iii) Explain the problems of using market multiples to estimate the value of shares. (10 marks) (Total: 30 Marks)
Question Four
O’Flannagan, CFA, is attempting to value AltoXenica, a pharma company with significant research and development (R&D) expenses. To do so she has decided to capitalize its R&D expenses for the past 9 years (in $ millions).
AltoXenica recently reported the following results for 2020 (in $ millions):
AltoXenica’s tax rate is 35.0%. The Company has a beta of 1.25 and the risk-free rate and market risk premium are expected to be 2.0% and 5.0%, respectively.
(i) Estimate the firm value of AltoXenica using the stable growth free cash flow (FCF) model. State any assumptions. (15 marks)
(ii) Discuss the validity of the reclassification of R&D as performed by O’Flannagan. Your answer should also comment (with worked examples where appropriate) on the impact of the reclassification on both valuation and performance measures for AltoXenica. (15 marks)
(Total: 30 Marks)
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