CHAPTER 1 - SOLUTIONS
INTRODUCTION TO VALUATION
Problem 1
e. All of the above
Problem 2
d. Value is determined by investor perceptions, but it is also determined by the
underlying earnings and cash flows. Perceptions must be based upon reality.
Problem 3
e. Either a,b, or c.
, CHAPTER 2- SOLUTIONS
INTRODUCTION TO VALUATION
Problem 1
A. False. The reverse is generally true.
B. True. The value of an asset is an increasing function of its cash flows.
C. True. The value of an asset is an increasing function of its life.
D. False. Generally, the greater the uncertainty, the lower is the value of an asset.
E. False. The present value effect will translate the value of an asset from infinite to finite
terms.
Problem 2
A. It might be difficult to estimate how much of the success of the private firm is due to the
owner's special skills and contacts.
B. Since the firm has no history of earnings and cash flow growth and, in fact, no potential
for either in the near future, estimating near term cash flows may be impossible.
C. The firm's current earnings and cash flows may be depressed due to the recession.
Other measures, such as debt-equity ratios and return on assets may also be affected.
D. Since discounted cash flow valuation requires positive cash flows some time in the near
term, valuing troubled firms, which are likely to have negative cash flows in the
foreseeable future, is likely to be difficult.
E. Restructuring alters the asset and liability mix of the firm, making it difficult to use
historical data on earnings growth and cash flows on the firm.
F. Unutilized assets do not produce cash flows and hence do not show up in discounted
cash flow valuation, unless they are considered separately.
Problem 3
a. Value of Equity = $ 3,224 (Discount cashflows to equity at the cost of equity – 12%)
b. Value of Firm = $ 5,149 (Discount cashflows to the firm at the cost of capital of 9.94%)
Problem 4
A. Average P/E Ratio = 31.98
B. No. Eliminate the outliers, because they are likely to skew the average. The average P/E
ratio without GET and King World is 25.16.
C. You are assuming that
(1) Paramount is similar to the average firm in the industry in terms of growth and risk.
(2) The marker is valuing communications firms correctly, on average.
, CHAPTER 3
UNDERSTANDING FINANCIAL STATEMENTS
Problem 1
a. Marketable securities are valued at book or market, whichever is lower. Hence
marketable securities are probably assessed at close to market value. Near-cash must
also be close to market value. Cash, of course, by definition is at market value.
b. Fixed Assets are valued at historical cost. Hence they were probably purchased for
the gross book value of fixed assets, i.e. 5486+199 = $5685.
From the value of $2016 for accumulated depreciation, we see that about 36.75% of
the value of the depreciable fixed assets has been written off in depreciation. Hence, if
we can assume that Coca-Cola uses straight-line depreciation, about two-fifths of the
life of the estimated life of these assets is over. If we know the average life of assets
in this industry, we can use that to estimate the age of these assets.
c. There are several reasons why current assets are more prominent in Coca-Cola’s
balance sheet than fixed assets. One, there is a large amount of cash and near-cash:
this might be due to impending expansion, perhaps investment in bottling operations.
Two, the Other Assets item includes investment in other Coca-Cola companies,
which are primarily manufacturing operations, such as bottlers. Hence, if the fixed
assets and current assets parts of these investments were included, the ratio of fixed
to current assets would probably be larger.
d. Even though the companies were sold off, Coca-Cola presumably still has some
ownership stake in these companies. To the extent that Coca-Cola does not have a
majority stake in these companies, they would not be consolidated into Coca-Cola’s
balance sheet. If these companies were primarily manufacturing companies, their
relatively large fixed-asset structure would not appear on Coca-Cola’s balance sheet
anymore.
Problem 2
, Dividend Discount Models 2
a. Total interest-bearing debt would equal short-term borrowings plus long-term
borrowings, i.e. 4462+687 = 5149m.
b. The paid-up capital represents the amount that Coca-Cola originally obtained for
the equity that it issued. This amount equals $3060m.
c. The larger the amount of time that has elapsed since the equity was originally
issued, the greater the proportion of shareholder equity that would be represented
by Retained Earnings, particularly for a firm that has plowed back a lot of its
earnings into its operations.
d. The book value of equity is $8.403 billion, which is much less than the market
value of $140 billion. This is because a large portion of Coca-Cola’s market value
is the present value of future growth and branc name value. This is not reflected
in the book value.
Problem 3
Coca-Cola’s brand name value does not appear in its balance sheet. Even though there is
an item called “Non-depreciable Fixed Assets,” it is too small, and cannot represent the
brand name value; it’s probably land. One way to adjust the balance sheet to reflect the
value of this asset is for Coca-Cola to set up a separate subsidiary that would buy the
rights to the brand name. The brand name value would then show up as an asset for the
subsidiary, which would then be reflected in Coca-Cola’s balance sheet as well, even if the
financial statements were consolidated.
Problem 4
a. The net working capital equals the difference between Current Assets and Current
Liabilities, i.e. 6380 - 8640 = - 2260.
Non-cash working capital removes Cash and Near Cash from the Current Assets
computation and interest-bearing short-term borrowings from the liabilities side. This
gives us - 2260 - 1648 + 4462 = 554.
INTRODUCTION TO VALUATION
Problem 1
e. All of the above
Problem 2
d. Value is determined by investor perceptions, but it is also determined by the
underlying earnings and cash flows. Perceptions must be based upon reality.
Problem 3
e. Either a,b, or c.
, CHAPTER 2- SOLUTIONS
INTRODUCTION TO VALUATION
Problem 1
A. False. The reverse is generally true.
B. True. The value of an asset is an increasing function of its cash flows.
C. True. The value of an asset is an increasing function of its life.
D. False. Generally, the greater the uncertainty, the lower is the value of an asset.
E. False. The present value effect will translate the value of an asset from infinite to finite
terms.
Problem 2
A. It might be difficult to estimate how much of the success of the private firm is due to the
owner's special skills and contacts.
B. Since the firm has no history of earnings and cash flow growth and, in fact, no potential
for either in the near future, estimating near term cash flows may be impossible.
C. The firm's current earnings and cash flows may be depressed due to the recession.
Other measures, such as debt-equity ratios and return on assets may also be affected.
D. Since discounted cash flow valuation requires positive cash flows some time in the near
term, valuing troubled firms, which are likely to have negative cash flows in the
foreseeable future, is likely to be difficult.
E. Restructuring alters the asset and liability mix of the firm, making it difficult to use
historical data on earnings growth and cash flows on the firm.
F. Unutilized assets do not produce cash flows and hence do not show up in discounted
cash flow valuation, unless they are considered separately.
Problem 3
a. Value of Equity = $ 3,224 (Discount cashflows to equity at the cost of equity – 12%)
b. Value of Firm = $ 5,149 (Discount cashflows to the firm at the cost of capital of 9.94%)
Problem 4
A. Average P/E Ratio = 31.98
B. No. Eliminate the outliers, because they are likely to skew the average. The average P/E
ratio without GET and King World is 25.16.
C. You are assuming that
(1) Paramount is similar to the average firm in the industry in terms of growth and risk.
(2) The marker is valuing communications firms correctly, on average.
, CHAPTER 3
UNDERSTANDING FINANCIAL STATEMENTS
Problem 1
a. Marketable securities are valued at book or market, whichever is lower. Hence
marketable securities are probably assessed at close to market value. Near-cash must
also be close to market value. Cash, of course, by definition is at market value.
b. Fixed Assets are valued at historical cost. Hence they were probably purchased for
the gross book value of fixed assets, i.e. 5486+199 = $5685.
From the value of $2016 for accumulated depreciation, we see that about 36.75% of
the value of the depreciable fixed assets has been written off in depreciation. Hence, if
we can assume that Coca-Cola uses straight-line depreciation, about two-fifths of the
life of the estimated life of these assets is over. If we know the average life of assets
in this industry, we can use that to estimate the age of these assets.
c. There are several reasons why current assets are more prominent in Coca-Cola’s
balance sheet than fixed assets. One, there is a large amount of cash and near-cash:
this might be due to impending expansion, perhaps investment in bottling operations.
Two, the Other Assets item includes investment in other Coca-Cola companies,
which are primarily manufacturing operations, such as bottlers. Hence, if the fixed
assets and current assets parts of these investments were included, the ratio of fixed
to current assets would probably be larger.
d. Even though the companies were sold off, Coca-Cola presumably still has some
ownership stake in these companies. To the extent that Coca-Cola does not have a
majority stake in these companies, they would not be consolidated into Coca-Cola’s
balance sheet. If these companies were primarily manufacturing companies, their
relatively large fixed-asset structure would not appear on Coca-Cola’s balance sheet
anymore.
Problem 2
, Dividend Discount Models 2
a. Total interest-bearing debt would equal short-term borrowings plus long-term
borrowings, i.e. 4462+687 = 5149m.
b. The paid-up capital represents the amount that Coca-Cola originally obtained for
the equity that it issued. This amount equals $3060m.
c. The larger the amount of time that has elapsed since the equity was originally
issued, the greater the proportion of shareholder equity that would be represented
by Retained Earnings, particularly for a firm that has plowed back a lot of its
earnings into its operations.
d. The book value of equity is $8.403 billion, which is much less than the market
value of $140 billion. This is because a large portion of Coca-Cola’s market value
is the present value of future growth and branc name value. This is not reflected
in the book value.
Problem 3
Coca-Cola’s brand name value does not appear in its balance sheet. Even though there is
an item called “Non-depreciable Fixed Assets,” it is too small, and cannot represent the
brand name value; it’s probably land. One way to adjust the balance sheet to reflect the
value of this asset is for Coca-Cola to set up a separate subsidiary that would buy the
rights to the brand name. The brand name value would then show up as an asset for the
subsidiary, which would then be reflected in Coca-Cola’s balance sheet as well, even if the
financial statements were consolidated.
Problem 4
a. The net working capital equals the difference between Current Assets and Current
Liabilities, i.e. 6380 - 8640 = - 2260.
Non-cash working capital removes Cash and Near Cash from the Current Assets
computation and interest-bearing short-term borrowings from the liabilities side. This
gives us - 2260 - 1648 + 4462 = 554.
