Finance 3 Essay Exam

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INVESTMENT ANALYSIS AND COMPANY VALUATION MODULE
NAME: JAHJA
This is an individual, open-book, open note exams. Every student is bounded by the Student’s Code of
Honor for academic honesty.
II. ESSAY (40 points)
Note: Please answer the questions in space provided below.
A. What would be the advantage of the DCF techniques in valuing a company? What are the
limitations of DCF techniques? (10 points)
The advantage of DCF techniques is this techniques can be used to give more closer approach to
intrinsic stock value. This method is depends on future expectations and based on free cash flow,
which is more less risk to manipulate if we compare to the use of ratio that calculated from P/L
and Balance Sheet. This techniques can be used if the analyst is confident with the assumption
and will be useful if there is a limited information.
The limitations of DCF technique is this technique depends so much on the information or
assumptions that put into the calculation at the first time. If there is some changes or un-correct
in inputs then it will be impacting to value of the company in a significant result. DCF valuations
also can fluctuate depends on how the market will unfold and how the company run their
operations.
B. Please summarize the process for computing the value of the firm based on the DCF techniques
(20 points)
 Estimate Cash Flow
To estimate cash flow, we can use some assumptions based on revenue growth, net
operating income, income tax rate, fixed capital investments rate and incremental
working capital rate. For estimating the revenue growth, we can got the result from
historic growth, analyst research, or fundamental determinants.


Estimate Discount Rate
We need a discount rate to calculate the net present value (NPV) of the cash flows.
Appropriate discount rate is depend to where the cash flow is going to be discounted. If
discounted to equity than the discount rate is cost of equity. If discounted to the firm than
the discount rate is cost of capital.



Calculate The Terminal Value
Terminal value is used to project the cashflow to infinity. This assume that cashflow will
stabilize after last projected year and remain the same in continuity.



Calculate fair value of company and equity
To have this fair value then we have to take the present value of the cash flow and
terminal value and divide them with discount rate. If the discount rate is cost of equity
then it will give value to to equity. By divide the amount of equity with the amount of
stock outstanding, we will get the value per share.

C. Compute the spot rate curve for period 3: (10 points)
Period

Years

YTM

Spot Rate

1
2
3

0.5
1.0
1.5

3.5
3.75
3.90

3.5
3.75
3.9046

PV
= 1.95/(1+z1) + 1.95/(1+z2)2 + 101.95/(1+z3)3
100
= 1.95/1.0175 + 1.95/1.01882 + 101.95/(1+z3)3
100
= 1.9164 + 1.8788 + 101.95/(1+z3)3
101.95/(1+z3)3
= 100 - 1.9164 + 1.8788
101.95/(1+z3)3
= 96.2048
96.2048 (1+z3)3= 101.95
(1+z3)3
= 101.95/96.2049
(1+z3)3
= 1.0597
(1+z3)
= 1.0597(1/3)
(1+z3)
= 1.019523
z3
= 1.019523 – 1
z3
= 1.019523 – 1
z3
= 0.019523
Spot Rate Period 3 : 3.9046%
D. Please show the computation
For the forward rate of 6th period is 6.53644
(10 points)

1 x (1+z1) x (1+1f1) x (1+1f2) x (1+1f3) x (1+1f4) x (1+1f5) x = 1*(1+z6) 6
1 x (1+0.016) x (1+0.019002) x (1+0.020587) x (1+0.026785) x (1+0.033705) x (1+1f5) = 1 x
(1+0.024711)6
1 x 1.016 x 1.019002 x 1.020587 x 1.026785 x 1.033705 x 1.032682 x (1+1f6) = 1 x 1.024711 6
1.12149 x (1+1f6) = 1.158143
1f6 = (1.158143/1.12149) – 1
1f6 = 0.03268
1f6 = 0.03268 x 2 x 100%
If6 = 6,5364%

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