Finance 7311

Sample Final Exam Questions

Questions 1-7 relate to Acme, Inc. Financial statement data for Acme are attached.

Selected Industry Ratios and other Data:

NWC/Sales ------------------0.10

Days Sales O/S ------------40.50

Inventory Turnover ---------7.25

Fixed Asset Turnover -----12.50

Debt/Total Capital* -----------.25

(* Total capital = interest bearing debt + equity; debt = interest bearing debt)

Times Interest Earned(TIE) --4.20

ROE -----------------------12.05%

ROIC ----------------------11.50%

Gross Margin ------------16.50%

Operating Margin ---------5.25%

Effective tax rate ---------34.00%

Market Rates:

Industry Beta ---------------1.20

Treasury Bond rates -------6.25

Equity risk premium -------7.50

Rating Information:

Market Information (industry avgs)

Price/Earnings --------------10.0

MV Firm/EBIT(1-t) --------11.0

MV Equity/BV Equity -----1.15

MV = market value; BV = book value; Firm value = Equity + interest bearing Debt

B_L = B_U * (1 + D/E * (1-t))

QUESTIONS

1. Analyze the past performance of Acme, as well as its cash flows and make recommendations for improvement.

2. Estimate Acme's current cost of capital and discuss Acme's current capital structure. Make any recommendations you deem appropriate, with estimates of the effect on cost of capital.

3. Business plans prepared by current management of Acme reveal the following:

• Estimated sales growth 20%, next 2 years
• Long-run sales growth 5%
• Capital Spending $3 million next 2 years; $2 million thereafter
• Depreciation $2 million/yr. into the foreseeable future
• Net Working Capital Reduce to 10% of sales
• Maintain current capital structure; approximately same `Times interest earned'
• Tax rate 34%

a. Prepare a pro-forma balance sheet for the following year only, using the blanks in the accompanying financial statements. (Simply project total net working capital; don't worry about its components.)

b. Estimate the value of the company under current management. (Ignore lack of marketability discounts.)

4. Motif Apparel Inc., a large, multi-divisonal manufacturer of widgets with significant industry expertise, marketing acumen, and financial capacity, is considering acquiring Acme. While Motif management has outlined many specific changes it would make in the operations of Acme, in general the effect of the changes would be to bring Acme's financial ratios in line with industry averages, with the exception of fixed asset turnover, which would reflect capital spending under management's plans. Additionally, Motif's international presence would likely increase long-run growth to 7%. What is the most Motif should pay for Acme? How much value (`synergy') would the acquisition create?

5. Suppose Acme's current management has also been disappointed with its performance and can also make the changes necessary to bring the company's performance back into line with industry averages. Acme does not have the international presence however. Management estimates that it can obtain the international presence with investments of 2 million per year over the next three years, with the first payment occurring immediately.

Should it pursue the international presence, assuming the required expenditures are currently deductible?

6. Current market expectations are that long-run industry growth will be in the 5%-6% range. Included in the data provided are some multiples derived from similar, publicly traded companies. What values are implied using these market multiples to determine value? How would you reconcile these results with those obtained in questions 3 & 4 above?

7. What factors, besides the sustainable growth rate, would you consider in attempting to estimate `g' for purposes of calculating a `terminal value'.

8. This course has focused on one theme: value.

What is value, and how does a firm create value?

9. Discuss diversification as a motive for acquiring another company. In particular, what are the pros and cons of such a strategy? What does the empirical evidence imply about such a strategy?

Acme Company

Financial Statements

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