Handout Problem 1.

You have been asked to value LoraLee enterprises, a privately held restaurant chain that is
expected to make an initial public offering in five years. You have been provided with the
following information:

The firm generated after-tax operating income of $ 10 million on revenues of $100 million in
the most recent year.
The firm is all equity funded, with all equity held by venture capitalists, and the book value of
equity at the start of the most recent year was $ 50 million.
The unlevered beta for publicly traded firms in the sector is 1.00; the correlation of correlation
of the venture capitalists portfolios with the market is 80%.
The riskfree rate is 3% and the equity risk premium is 5%

a. If you expect that after-tax operating income will grow 10% a year for the next 5 years and
that the firm will maintain its current return on capital, estimate the expected cash flows each
year for the next 5 years.

b. At the end of year 5, the firm plans to go public. It plans to remain all equity funded and the
return on capital will be 12% in perpetuity, after year 5. If the firm will be in stable growth,
growing 3% a year after year 5, estimate the value at the end of year 5.

c. Estimate the value of the Firm to venture capitalist.

Handout Problem 2

Cavuto Inc. is a private company, in the software business. The owner, who has her entire wealth
invested in the business, has come to you for some advice on a proposed acquisition of Soros Inc,
a private retail business, also owned by an undiversified individual. You have collected the
following information on the two companies:

Cavuto reported after-tax operating income of $ 10 million last year on a book value of capital
of $ 50 million. The firm is in stable growth, growing 4% a year in perpetuity.
Soros reported after-tax operating income of $ 5 million last year on a book value of capital of
$ 40 million. The firm is in stable growth as well, growing 4% a year in perpetuity.

Both firms are entirely equity funded. You have collected the following information on publicly
traded firms in the software and the retail businesses:

Business Unlevered Beta Correlation with the market

Software 1.20 30%
Retail 0.90 40%

The tax rate is 40%. The riskfree rate is 5% and the market risk premium is 4%.

a. Estimate the value of Cavuto as a stand-alone firm.

b. Estimate the value of Soros Inc. as a stand alone firm.
c. Estimate the value of synergy in the acquisition. The combined firms equity will have a
correlation of 50% with the market and you can assume that there are no operating synergies in
this merger.
Handout Problem 3

Nostalgia Inc. is a small, privately owned firm that sells antique furnishings. In the most recent
year, the firm generated $ 1.5 million in after-tax operating income on revenues of $ 10 million;
the firm reported book value of equity of $ 5 million and book value of debt of $2.5 million at
the beginning of the year. During the year, the firm invested $ 1 million in a new warehouse for
furniture and reported depreciation of $400,000 in its income statement. The firms only working
capital item is its inventory, which increased by $150,000 during the course of the year. You
have been asked by the owner to appraise the value of the company for sale and collected the
following information on publicly traded counterparts:

Publicly traded furniture companies have an average levered beta of 1.15 and an average
market debt to equity ratio of 25%. The pre-tax cost of borrowing, on average, at these firms is
7%. The marginal tax rate for both private and publicly traded firms is 40%. On average, the
correlation between furniture firms and the market is 0.40.
The treasury bond rate is 5% and the equity risk premium is 4%.

a. Esimate the free cash flow to the firm to Nostalgia in the most recent year.
b. Assuming that the firm maintains its existing return on capital and reinvestment rate for the
next 5 years, estimate the expected annual growth rate for that period.
c. If you were valuing this company for a sale in a private transaction (to an undiversified
individual), what cost of capital would you use for the firm? (You can assume that this firm
operates at the industry average debt to equity ratio and shares the same cost of debt)
Handout Problem 4

Prius Enterprises, a publicly traded company, is considering acquiring Juniper Inc, a private
company in the same business. Assume that both Prius and Juniper are stable growth companies
funded entirely with equity, each with expected free cash flows next year of $ 10 million, and
each expected to grow 4% a year in perpetuity. The unlevered beta for the sector is 0.80 but only
40% of the risk in the business is market risk. The riskfree rate is 5% and the equity risk
premium is 4%. (Tax rate = 40% for both firms)

a. Prius Enterprises has 5 million shares outstanding. Estimate the value per share for Prius as a
stand-alone firm.
b. Estimate the value of Juniper as a stand-alone firm to its existing owner (who is not
diversified).
c. Assume that Prius pays a premium of 50% over the estimated value of Juniper (from part b).
Estimate the value per share of Prius after the transaction.
d. Now assume that Prius will be able to write up the book value of Junipers assets from the
existing value of $ 100 million to $ 150 million. Assuming that these assets have five years of
depreciable life left and that you use straight line depreciation, estimate the value of the
additional tax savings that will accrue from the transaction.