Show your work in excel worksheet; showing your work will also ease getting partial credit. Using the templates will make it easier for you to solve the problems. I have shown the available points for each problem.

Question 1. Answer the problem #8-9 on page 299-302 from the TM textbook. (25 points)

Question 2. Answer the problem #9-9 on pages 352-353 from the TM textbook. (30 points)

Question 3. Answer the problem #10-7 on pages 394-395 from the TM textbook. (25 points)

Question 4. Answer the problem #11-5 on page 429 from the TM textbook.(20 points)

GOOD LUCK.

Problem 8-9

Intel Corporation is a leading manufacturer of semiconductor chips. The firm was incorporated in 1968 in Santa Clara, California, and represents one of the greatest success stories of the computer age. Although Intel continues to grow, the industry in which it operates has matured so there is some question whether the firm should be evaluated as a high-growth company or stable-growth company from now on. For example, in December 2007, the firm's shares were trading for $20.88 and has a price-earnings ratio of 17.622. Compared to Google Inc.’s price-earnings ratio of 53.71 on the same date, it would appear that the decision has already been made by the market.

Intel's expected earnings for 2007 are $1.13 per share, and its payout ratio was 48%. Furthermore, selected financial data for the sector, industry, and seven of the largest firms (including Intel) are found below in Exhibit P8-9.1on page 301

a. Is Intel's current stock price of $20.88 reasonable in light of its sector, industry, and comparison firms?

b. Intel has a beta coefficient equal to 1.66. If we assume a risk free rate of 5.02% and a market risk premium of 5%, what is your estimate of the required rate of return for Intel's stock using the CAPM? What rate of growth in earnings is consistent with Intel's policy of paying out 48% of earnings in dividends and the firm's historical return on equity? Using your estimated growth rate, what is the value of Intel’s shares using the Gordon (single-stage) growth model? Analyze the reasonableness of your estimated value per share using the Gordon model.

c. Using your analysis in problem 8-9(b), what growth rate is consistent with Intel's current share price of $20.88?

d. Analysts expect Intel's earnings to grow at a rate of 12% per year over the next five years. What rate of growth from year 6 forward (forever) is needed to warrant Intel's current stock price (use your CAPM estimate of the required rate of return on equity)? (Hint: use a two-stage growth model where Intel's earnings grow for five years at 12% and from year 6 forward at a constant rate.)

Problem 9-9 TERMINAL-VALUE ANLYSIS

Terminal value refers to the valuation attached to the end of the planning period; it captures the value of all subsequent cash flows. Estimate the value today for each of the following sets of future cash flow forecasts.

a. Claymore mining company anticipates that it will earn firm FCFs of $4 million per year for each of the next five years. Beginning in year 6, the firm will earn FCF of $5 million per year for the indefinite future. If claymore’s cost of capital is 10%, what is the value of the firm’s future cash flows?

b. Shameless commerce Inc. has no outstanding debt and is being evaluated as a possible acquisition. Shameless’s FCF for the next five years are projected to be $1 million per year, and, beginning in year 6, the cash flows are expected to begin growing at the anticipated rate of inflation which is currently 3% per annum. If the cost of capital for shameless is 10%, what is your estimate of the present value of the FCF?

c. Dustin electric Inc. is about to be acquired by the firm’s management from the firm’s founder for 15 million in cash. The purchase price will be financed with $10 million in notes that are to be repaid in 2 million increments over the next five years. At the end of this five-year period, the firm will have no remaining debt. The FCFs are expected to be $3 million a year for the next five years. Beginning in year 6, the FCFs are expected to grow at a rate of 2% per year into the indefinite future. If the unlevered cost of equity for Dustin is approximately 15% and the firm’s borrowing rate on the buyout debt is 10% (before taxes at a rate of 30%), what is your estimate of the value of the firm?

Problem 10-7 VC VALUATION AND DEAL STRUCTURING

Brazos Winery was established eight years ago by Anna and Jerry Lutz with the purchase of 200 acres of land. The purchase was followed by a period of intensive planting and development of the grape vineyard. The vineyard is now entering its second year of production.

In March 2015, the Lutz determined that they needed to raise $500,000 to purchase equipment to bottle their private-label wines. Unfortunately, they have reached the limits of what their banker can finance and have put all their personal financial resources into the business. In short, they need more equity capital, and they cannot provide it themselves.

Their banker recommended that they contact a venture capital (VC) firm in New Orleans that sometimes makes investments in ventures such as the Brazos Winery. He also recommended that they prepare for the meeting by organizing their financial forecast for the next five years. The banker explained that VCs generally target a five-year term for their investments, so it was important that they provide the information needed to value the winery at the end of five years.

After doing a careful analysis, the Lutzes, estimate that their venture will generate earnings before interest, taxes, depreciation, and amortization (EBITDA) in five years of $1.2 million. In addition to the EBITDA forecast, the Lutzes estimate that they will need to borrow $2.4 million by 2019 to fund additional expansion of their operations. Their banker indicated that his bank could be counted on for $2 million in debt, assuming they were successful in raising the needed equity funds from the VC. Furthermore, the remaining $400,000 would be in the form of accounts payable. Finally, the Lutzes believe that their cash balance will reach $300,000 at the end of five years.

The Lutzes are particularly concerned about how much of the firm’s ownership they will have to give up in order to entice the VC to invest. The VC offers three alternative ways of funding the winery’s $500,000 financing requirements; each alternative calls for a different ownership share:

• Straight common stock that pays no dividend. With this option, the VC asks for 60% of the firm’s common stock in five years.
• Convertible debt paying 10% annual interest and 40% of the firm’s common stock at conversion in year 5.
• Convertible preferred stock with a 10% annual dividend and the right to convert the preferred stock into 45% ownership of the firm’s common stock at the end of year 5.

1. If the VC estimates that the winery should have an enterprise value equal to six to seven times estimated EBITDA in five years, what do you estimate the value of the winery to be in 2019? What will the equity in the firm be worth? (Hint: Consider both the six- and seven-times-EBITDA multiple.)
2. Based on the deal terms offered, what rate of return does the VC require for each of the three financing alternatives? Which alternative should the Lutzes select based on the expected cost of financing?
3. What is the pre- and post-money value of the firm based on the three sets of deal terms offered by the VC? Why are the estimates different for each of the deal structures?
4. How is the cost of financing affected by the EBITDA multiple used to determine enterprise value? Is it in the VC’s best interest to exaggerate the size of the multiple or to be conservative in his estimates? Is it in the entrepreneurs’ best interest to exaggerate the estimated EBITDA levels or to be conservative? If entrepreneurs are naturally optimistic about their firm’s prospects, how should the VC incorporate this into his deal-structuring considerations?
5. Discuss the pros and cons of the alternative sources of financing.

Problem 11-5 USING DERIVATIVES TO ANALYZE A NATURAL GAS INVESTMENT

Morrison Oil and Gas is faced with an interesting investment opportunity. The investment involves the exploration for a significant deposit of natural gas in southeastern Louisiana near Cameron. The area has long been known for its oil and gas production, and the new opportunity involves developing and producing 50,000 cubic feet (MCF) of gas. Natural gas is currently trading around $14.03 per MCF; the price next year, when the gas is produced and sold, could be as high as $18.16 or as low as $12.17. Furthermore, the forward price of gas one year hence is currently $14.87. If Morrison acquires the property, it will face a cost of $4.00 per MCF to develop the gas.

The company trying to sell the gas field has a note of $450 million on the property that requires repayment in one year plus 10% interest. If Morrison buys the property, it will have to assume this note and responsibility for repaying it. However, the note is nonrecourse; if the owner of the property decides not to develop the property in on year, the owner can simply transfer ownership of the property to the lender.

The property's current owner is a major oil company that is in the process of fighting off an attempted takeover; thus, it needs cash. The asking price for the equity in the property is $50 million. The problem faced by Morrison's analysts is whether the equity is worth this amount. Answer the following assuming zero taxes.

a) Estimate the value of the equity in the project for the case where all the gas is sold forward at the $14.87-per-MCF price. The risk-free rate of interest is currently 6%.

b) Alternatively, Morrison could choose to wait a year to decide on developing it. By delaying, the firm chooses whether or not to develop the property based on the price per MCF at year-end. Analyze the value of the equity of the property under this scenario.

c) The equity in the property is essentially a call option on 50 MCF of natural gas. Under the conditions stated in the problem, what is the value of a one-year call option on natural gas with an exercise price of 13.90 MCF worth today? (hint: use the binomial option pricing model).