INVESTMENT AND PRIVATE BANKING
WEEKS 3 AND 4 ADDITIONAL VALUATION
PRACTICE QUESTIONS (Note: Questions adapted from CFA)
Question 1 – FCFF:
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Inc., incorporated on 31 December 2009 with initial capital infusions of $224,000 of debt and $336,000 of common stock, acts as a distributor of industrial goods. The company managers immediately invested the initial capital in fixed capital of $500,000 and working capital of $60,000. Working capital initially consisted solely of inventory. The fixed capital consisted of non-depreciable property of $50,000 and depreciable property of $450,000. The depreciable property has a 10-year useful like with no salvage value. Exhibits 1,2 and 3 provide Cane¡¯s financial statements for the three years following incorporation. Starting with net income, calculate Cane¡¯s FCFF for each year.
Exhibit 1 , Inc. Income Statement (in Thousands)
Years Ending 31 December
Depreciation Expense Operating Income
Interest expense (at 7 percent) Income before taxers
Income taxes (at 30 percent) Net Income
2010 2011 $ 200.00 $ 220.00
2012 242.00
54.45 187.55 18.97 168.58 50.58
45.00 49.50 155.00 170.50 15.68 17.25 139.32 153.25 41.80 45.97
97.52 $ 107.28
Exhibit 2 , Inc. Balance Sheet (in Thousands)
Years Ending 31 December
2009 Cash $ –
$ 108.92 $ 228.74
100.00 110.00 66.00 72.60 274.92 411.34 500.00 550.00 45.00 94.50
$ 729.92 $ 866.84
$ 50.00 $ 55.00
50.00 55.00 246.40 271.04 336.00 336.00
97.52 204.80 $ 729.92 $ 866.84
121.00 79.86 561.40 605.00 148.95
$ 1,017.45
60.50 298.14 336.00 332.80
$ 1,027.44
Accounts receivable
Inventory 60.00
Current Assets Fixed assets
less: Accumulated depreciation Total Assets
Accounts payable
Current portion of long-term debt
Current Liabilities Long-term debt Common stock Retained earnings
Total Liabilities and equity
60.00 500.00 –
– 224.00 336.00 –
Exhibit 3 , Inc. Working Capital (in Thousands)
Years Ending 31 December
Current assets excluding cash
Accounts receivable Inventory
Total Current Assets excluding cash
Current liabilities excluding short-term debt
Accounts payable
Working Capital
Increase in working capital
Question 2 – Multiples:
2009 2010 2011
$ – $ 100.00 $ 110.00 60.00 66.00 72.60 60.00 166.00 182.60
– 50.00 55.00 $ 60.00 $ 116.00 $ 127.60
121.00 79.86 200.86
Exhibit 1 Trailing P/Es of Telecommunication Services Companies Company
AT&T (NYSE: T)
BCE Inc. (NYSE: BCE; TSC: BCE)
Centurytel (NYSE: CTL)
Equinix (NASDAQ: EQIX)
Frontier Communications Corp. (NASDAQ: FTR) Verizon Communications (NYSE: VZ) Windstream Corp. (NYSE: WIN)
Trailing P/E 25.73 14.49 18.86 131.28 43.30 86.06 36.91 50.95 36.91
60.50 140.36 $ 11.60 $ 12.76
As a telecommunication industry analyst at an investment bank, you are valuing Verizon Communications, Inc (NYSE: VZ), one of the world¡¯s largest leading telecommunications companies. The valuation metric that you have selected is the trailing P/E. You are evaluating the P/E using the median trailing P/E of peer-group companies as the benchmark value. According to GICS, VZ is in the telecommunications services sector and, within it, the integrated telecommunications services subindustry. Exhibit 1 presents the relevant data. (Note that although BCE Inc. is a Canadian company, it is classified in this peer group.)
Based on the data in Exhibit 1(above), address the following:
1. Given the definition of the benchmark stated above, determine the most
appropriate benchmark value of the P/E for VZ.
2. State whether VZ is relatively fairly valued, relatively overvalued or relatively
undervalued, assuming no differences in fundamentals among the peer
group companies. Justify your answer.
3. Identify the stocks in this group of telecommunication companies that appear
to be relatively undervalued when the median trailing P/E is used as a benchmark. Explain what further analysis might be appropriate to confirm your answer.
Extension:
Continuing with the valuation of telecommunication service providers, you gather information on selected fundamentals related to risk (beta), profitability, (five-year earnings growth forecasts), and valuation (trailing and forward P/Es). These data are reported in Exhibit 2 (below), which lists companies in order of descending earnings growth forecast. The use of forward P/Es recognizes that differences in trailing P/Es could be the result of transitory effects on earnings.
Exhibit 2 Valuation Data for Telecommunication Services Companies
Equinix (NASDAQ: EQIX)
Frontier Communications Corp. (NASDAQ: FTR) Verizon Communications (NYSE: VZ)
AT&T (NYSE: T)
BCE Inc. (NYSE: BCE; TSC: BCE)
Centurytel (NYSE: CTL)
Windstream Corp. (NYSE: WIN)
Trailing Forward P/E P/E 131.28 43.97 43.30 18.83 86.06 14.40 25.73 12.62 14.49 14.12 18.86 12.04 36.91 18.66 50.95 19.23 36.91 14.40
Five-year EPS Forward Beta Growth Forecast PEG
0.25 1.74 1.26 0.22 0.86 0.78 0.10 1.41 0.38 0.06 1.95 0.40 0.03 4.71 0.76 0.02 8.92 0.89
-0.12 NM 0.89 0.08 3.27 0.77 6.46 1.85 0.78
Note: NM = Not meaningful. The five-year EPS growth forecast for WIN is a negative number which would result in a negative PEG.
Based on the data in Exhibit 2 (above), answer the following questions:
1. T, BCE, and CTL were identified as possibly relatively undervalued compared with the peer group as a whole, and WIN was identified as relatively fairly valued., What does the additional information in Exhibit 2 relating to profitability and risk suggest about the relative valuation of these
2. T has a consensus year-ahead EPS forecast of $2,69. Suppose the median
P/E of 14.40 for the peer group is subjectively adjusted upwards to 15.00 to reflect T¡¯s superior profitability and below-average risk. Estimate T¡¯s intrinsic value.
3. T¡¯s current market price is $33.99. State whether T appears to be fairly valued, overvalued, or undervalued when compared with the intrinsic value estimated in answer to Part 2 above.
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