Question 1 (Adapted from a past paper) a. At the end of the last financial year, Company Q generated earnings before interest and tax (EBIT) of £6.5m. It depreciated its fixed assets by £1.2m and invested £3m and £1m in new capital equipment and working capital, respectively. Q pays corporate tax at a long-term effective rate of 20%. Over the next two years, EBIT is expected to grow at 5%, falling to 3% for the next three years. All types of investment and depreciation are not expected to change. Q is financed by debt, worth £20m, and equity, with a current market value of £80m. Its levered beta is 0.9. The rate of return on government bonds is 3%. The return on Q's debt is 4.5%. The market risk premium is 2%. If Q's EBIT is expected to remain unchanged after the forecast period, what is the value of Q? Hint: You need to use CAPM to calculate the return on equity. b. You are unsatisfied with your valuation in 1a., so you decide to try the multiples approach instead. Explain why this could be useful. Data on the ratio of enterprise value to EBIT for Q's competitors are given below. What value would you give to Q? Company R ST U V W X Y Z EV/EBIT 2.5 7 8.5 8 9 15 7.5 6.8 9.2

Question 1 (Adapted from a past paper) a. At the end of the last financial year, Company Q generated earnings before interest and tax (EBIT) of £6.5m. It depreciated its fixed assets by £1.2m and invested £3m and £1m in new capital equipment and working capital, respectively. Q pays corporate tax at a long-term effective rate of 20%. Over the next two years, EBIT is expected to grow at 5%, falling to 3% for the next three years. All types of investment and depreciation are not expected to change. Q is financed by debt, worth £20m, and equity, with a current market value of £80m. Its levered beta is 0.9. The rate of return on government bonds is 3%. The return on Q's debt is 4.5%. The market risk premium is 2%. If Q's EBIT is expected to remain unchanged after the forecast period, what is the value of Q? Hint: You need to use CAPM to calculate the return on equity. b. You are unsatisfied with your valuation in 1a., so you decide to try the multiples approach instead. Explain why this could be useful. Data on the ratio of enterprise value to EBIT for Q's competitors are given below. What value would you give to Q? Company R ST U V W X Y Z EV/EBIT 2.5 7 8.5 8 9 15 7.5 6.8 9.2

Managerial Accounting: The Cornerstone of Business Decision-Making

7th Edition

ISBN:9781337115773

Author:Maryanne M. Mowen, Don R. Hansen, Dan L. Heitger

Publisher:Maryanne M. Mowen, Don R. Hansen, Dan L. Heitger

Chapter15: Financial Statement Analysis

Section: Chapter Questions

Problem 52E: Juroe Company provided the following income statement for last year: Juroes balance sheet as of...

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