INV3701 ASSIGNMENT 1 FOR 2025 - DUE 04 SEPTEMBER 2025

QUESTION 1 [10 MARKS] An analyst has been asked to value telecommunication companies, Fluid 5G Networks Ltd and Enterprise 5G Networks Ltd. The telecommunications industry is a mature industry with few competitors. One segment that is growing is 5G Networks; while the telecommunications sector is expected to grow at a steady rate of 5%, the 5G Networks segment is expected to grow at 10%. Fluid is the largest company in the 5G Networks segment. Fluid is considered a very stable company within the telecommunications sector and the 5G Networks segment. Fluid has an equity beta of 1.00. The current market price of Fluid’s share is R14.85. The analyst collects selected financial information from Fluid’s income statement and cash flow information (for the last fiscal year) and from Fluid’s balance sheet (for the last two fiscal year ends). The information is shown in Exhibit 1. There is no preferred share, and no longterm asset sales occurred in 2024. INV3701 ASSIGNMENT 1, SEMESTER 2, 2025 2 Exhibit 1: Selected Fluid Financial Information (R million except for rates and ratios) Income statement 2024 EBITDA R1 461 Operating income R1 169 Interest expense R150 Income tax rate 30% Dividends R357 Balance sheet Total current assets R2 408 R2 577 Net PPE R3 794 R4 150 Notes payable R600 R644 Long-term debt R2 020 R2 070 Total liabilities R3 210 R3 378 Total equity R2 992 R3 349 Other information 2024 Cash flow from operations (CFO) R1 020 Investment in fixed capital (FCInv) R500 Risk-free rate 3.00% Cost of debt 6.00% Cost of equity 8.00% Target D/E ratio 1.00 Enterprise is the fifth largest company in the 5G Networks segment of the telecommunications sector. Enterprise is considered a growth company within the telecommunications sector and the 5G Networks segment. Enterprise has not issued bonds, and all of Enterprise’s debt is considered short and medium-term. For the fiscal year 2024, free cash flow to the firm (FCFF) is R143 million, and free cash flow to equity (FCFE) is R120 million. Enterprise pays no dividends. Enterprise’s earnings are expected to grow at 14% for three years, and then at the expected overall rate of growth in the 5G Networks segment into perpetuity. Enterprise’s equity beta is 1.20. The risk-free rate is 3%. INV3701 ASSIGNMENT 1, SEMESTER 2, 2025 3 The analyst has been asked to investigate the effect each of the following corporate events, if taken during 2024, would have on Fluid’s FCFE: a) A 20% increase in dividends per share. b) Repurchase of 25% of the firm’s outstanding shares using cash. c) New common share offering that would increase shares outstanding by 30%. d) New issue of convertible bonds that are not callable for five years and would increase the level of debt by 10%. 1.1 The free cash flow to equity (FCFE) for Fluid for 2024 is closest to. (2 marks) 1.2 Assuming that the growth of Fluid earnings is equal to the overall telecommunications sector growth rate, the value of the firm is closest to. (2 marks) 1.3 The estimated value of Enterprise using FCFE is closest to. (2 marks) 1.4 Assume the estimated value of Fluid’s equity per share is R17.10, then based on the current market price, is Fluid’s share overvalued, fairly valued or undervalued? Justify your answer. (2 marks) 1.5 Which corporate event that the analyst is investigating is most likely to have the largest effect on Fluid’s FCFE in 2024? Justify your answer (2 marks) INV3701 ASSIGNMENT 1, SEMESTER 2, 2025 4 QUESTION 2 [6 MARKS] Lee Mukwevho, CFA, is analysing the returns of Sport Apparel Ltd, a manufacturer of highend sportswear. Lee intends to use the Fama-French model to analyse the firm. Sport Apparel is a small-cap growth share that has traded at a low market-to-book value in recent years. Lee’s analysis has provided useful information to consider. The return on a value-weighted market index minus the risk-free rate is 5.50%, the small-cap return premium is 3.10%, the value return premium is 2.20%, and the liquidity premium is 3.30%. The risk-free rate is 3.40%. The market, size, relative value, and liquidity betas for Sports Apparel are 0.70, -0.20, 1.40, and 1.20, respectively. Lee has chosen to use the Gordon growth model in estimating the appropriate equity risk premium. Lee is also attempting to determine the most appropriate method for determining the required return for Valley Ltd, a closely held company that is considering a debt issue within the next year. The company has previously issued debt securities to the public, relying instead on bank financing. He realises that there are several models to consider, including the multifactor model, capital asset premium model (CAPM) and build-up models. 2.1 According to the Fama-French Model, the estimate of the required return for Sport Apparel is closest to. (2 marks) 2.2 Lee’s choice of the Gordon growth model is an example of which type of method for estimating the equity risk premium? Justify your answer. (2 marks) 2.3 Which method is most appropriate for Lee to consider in determining the required return for Valley? Justify your answer. (2 marks) INV3701 ASSIGNMENT 1, SEMESTER 2, 2025 5 QUESTION 3 [4 MARKS] An INV3701 student is analysing the value of Pula Ltd as of late June 2025. The share price of Pula is R19.74. The company’s dividend per share for the fiscal year ending 30 June 2025 was R2.50. You expect the dividend to increase by 10% for the next five years and increase by 4% per year forever. You estimate the required return on equity of Pula Ltd to be 8%. 3.1 Estimate the intrinsic value of the share of Pula Limited using the multistage dividend discount model. (3 marks) 3.2 Determine whether Pula is fairly valued, undervalued or overvalued. (1 mark)