University:
CFA Institute
Course:
CFA Level 2 | Equity
Academic year:

2020
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372

Pages:

4
Author:

anon

CFA Level 2 - Equity Session 12-Reading 46 Private Company Valuation-LOS e (Practice Questions, Sample Questions) 1. Given the following figures, calculate the normalized EBITDA for a financial and strategic buyer. Reported EBITDA $4,500,000 Current Executive Compensation $700,000 Market-Based Executive Compensation $620,000 Current SG&A expenses $6,300,000 SG&A expenses after synergistic savings $5,600,000 Current Lease Rate $300,000 Market-Based Lease Rate $390,000 The normalized EBITDA for each type of buyer is: Financial Buyer Strategic Buyer A) $4,190,000 $4,890,000 B) $4,670,000 $5,370,000 C) $4,490,000 $5,190,000 : Both strategic and financial buyers will attempt to reduce executive compensation to market levels by $80,000 ($700,000 ? $620,000). They will also have to pay a higher lease rate of $90,000 ($390,000 ? $300,000). So the adjustment for both buyers to generate normalized EBITDA is $4,500,000 + $80,000 ? $90,000 = $4,490,000. However, only a strategic buyer will be able to realize synergistic savings of $700,000 ($6,300,000 ? $5,600,000). So normalized EBITDA for a strategic buyer is $5,190,000 and for a financial buyer it is $4,490,000 2. Given the following figures, calculate the FCFF. Assume the earnings and expenses are normalized and that capital expenditures will cover depreciation plus 3 percent of the firm’s incremental revenues. Current Revenues $30,000,000 Revenue growth 6% Gross profit margin 20% Depreciation expense as a percent of sales 1% Working capital as a percent of sales 15% SG&A expenses $3,800,000 Tax rate 30% A) $927,400. B) $1,785,400. C) $1,245,400 The answer is calculated as follows: : Pro forma Income Statement Revenues $31,800,000 Cost of Goods Sold $25,440,000 Gross Profit $6,360,000 SG&A Expenses $3,800,000 Pro forma EBITDA $2,560,000 Depreciation and amortization $318,000 Pro forma EBIT $2,242,000 Pro forma taxes on EBIT $672,600 Operating income after tax $1,569,400 Adjustments to obtain FCFF Plus: Depreciation and amortization $318,000 Minus: Capital expenditures $372,000 Minus: Increase in working capital $270,000 FCFF $1,245,400 The following provides a line by line explanation for the above calculations. Pro forma Income Statement Explanation Revenues Current revenues times the growth rate: $30,000,000 × (1.06) Cost of Goods Sold Revenues times one minus the gross profit margin: $31,800,000 × (1 ? 0.20) Gross Profit Revenues times the gross profit margin: $31,800,000 × 0.20 SG&A Expenses Given in the question Pro forma EBITDA Gross Profit minus SG&A expenses: $6,360,000 ? $3,800,000 Depreciation and amortization Revenues times the given depreciation expense: $31,800,000 × 0.01 Pro forma EBIT EBITDA minus depreciation and amortization: $2,560,000 ? $318,000 Pro forma taxes on EBIT EBIT times tax rate: $2,242,000 × 0.30 Operating income after tax EBIT minus taxes: $2,242,000 ? $672,600 Adjustments to obtain FCFF Plus: Depreciation and amort. Add back noncash charges from above Minus: Capital expenditures Expenditures cover depreciation and increase with revenues: $318,000 + (0.03 × $31,800,000 ? $30,000,000) Minus: Increase in working capital The working capital will increase as revenues increase: (0.15 × $31,800,000 ? $30,000,000) FCFF Operating income net of the adjustments above 3. Which of the following best describes the use of FCFF and FCFE when used in private firm valuation? A) FCFF is usually favored if the firm is going to change its capital structure because the WACC is less sensitive to leverage changes than the cost of equity. B) FCFE is usually favored if the firm is going to change its capital structure because the equityholders are usually the investors requesting the valuation. C) FCFE is usually favored if the firm is going to change its capital structure because the cost of equity is less sensitive to leverage changes than the WACC : Free cash flow to the firm (FCFF) can be used to value the firm as a whole and free cash flow to equity (FCFE) can be used for equity. FCFF is usually favored if the firm is going to significantly change its capital structure. The reason is that the discount rate used for FCFF valuation, the weighted average cost of capital (WACC), is less sensitive to leverage changes than the discount rate used for FCFE valuation, the cost of equity. Thus, the FCFF valuation will not vary as much as the FCFE valuation

CFA Level 2 - Equity: Private Company Valuation

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