Time value of money

1) In discounted cash flow valuation, the value of an asset is the sum of the _________ of expected future cash flows on the asset.

a. Sum

b. Present value

c. Future value

d. Terminal value

2) In your own words, list three advantages and disadvantages of the DCF method?

3) In your own words, list three advantages and disadvantages of the Relative Valuation method?

4) What is the Net Present Value (NPV) of an investment project with an initial cost of $6 million and positive cash flows of $1.6 million at the end of the year 1, $2.4 million at the end of year 2, and $2.8 million at the end of year 3. Use 10% as the discount rate. Will you accept or reject this project?

5) Suppose Dexter’s target capital structure is as follows:

W_d=0.40 W_ps=0.10 W_ce=0.50;

Its before-tax cost of debt is 8.0%, cost of equity is 12.0%, cost of preferred stock is 8.4%, and the marginal tax rate is 40%. Calculate Dexter’s Weighted Average Cost of Capital (WACC).

6) Grammy phone is a cellular firm that reported a net income of $50 million in the most recent financial year. The firm had $1 billion in debt, on which it reported interest expenses of $100 million in the most recent financial year. The firm had depreciation of $100 million for the year and capital expenditures were 200% of depreciation. The firm had a cost of capital of 11%. Assuming that there is no working capital requirement, and using a constant growth rate of 4% in perpetuity, estimate the value of the firm. Also assume that the risk premium is 5.5% and the tax rate is 40%.

7) Briefly explain in your own words the difference between firm and equity valuation?

8) What is terminal value, and how is it estimated?