Corporate Finance Problem Set #2

Question 1:

The premise of DCF analysis is the principle that the value of a company, division, business, or collection of assets can be derived from the present value of its projected free cash flow, discounted by the cost of capital.

Question 2:

DCF is known as intrinsic valuation approach because DCF is derived from fundamental analysis from assumptions of the company’s performance without references to the market value or comparable companies. It is an important check to market-based approach because market-based approach can be distorted by factors such as market conditions, or availability of comparable companies.

Question 3:

C ) 5 Years

Question 4:

During technology bloom, the market was relatively high. Valuation multiples were distorted and corporate earnings were not sustainable. The market values of the companies would be traded at a much higher cost than the actual value supported by their ability to generate free cash flow. DCF would then give a more accurate valuation of the value of the company.

Question 5:

($ in millions)

EBITDA = 1,080 x 15% = $162

D&A = 1,080 x 2% = $21.6

EBIT=EBITDA – D&A = $162 - $21.6 = $140.4

NOPAD = EBIT x (1-tax rate) = $140.4 x (1- 0.38) = $87.048

CAPEX = $1,080 x 2% = $21.6

Free Cash Flow = NOPAD + D&A – CAPEX – net change in NWC

=$87.048 + $21.6 -$21.6 -$8.0 =$79.048

Question 6:

When projecting terminal year Free Cash Flow, an important factor to consider is that the terminal year performance is representative of the year (steady, normalized) and should not be skewed to a cyclical high or low.