Security Analysis Assignment 2

Security Analysis Assignment 2

[1] Unlevered beta

Tantrus has a bottom-upleveredbeta of 1.4810. The CFO has estimated the unlevered beta of the firm at 1.2740, but you think he has made a mistake. The company’s stock

price is €7.50/share, with one million shares outstanding. The equity capital of Tantrus is worth three times more than its debt equity. The tax rate is 35%.

Questions: (1) what is the mistake made by the CFO?; (2) calculate the correctunleveredbeta for Tantrus.

[2] Equity Risk Premium

You need to calculate the Equity Risk Premium for Cactus Electronics, a firm that operates in the USA (18.80% of sales), South Africa (29.00% of sales), South Korea

(37.70% of sales) and India (14.50% of sales). You are provided with the values for each country’s stock exchange and sovereign bond market from 2010 to 2016 (see

Excel template). You also have the corresponding CDS spreads.

Use the following formulas:

USA Equity Risk Premium (ERP) =rM –rF

Country risk premium = USA ERP + Country CDS * ?E/ ?B

Company ERP = weighted-average (by sales) of each ERP

Note:rM is the expected return on the US market,rF is the US risk-free rate, CDS is a country’s sovereign credit default swap spread, ?E is a country’s standard

deviation of the equity market and ?B is a country’s standard deviation of the sovereign bond market (please use samples to calculate the standard deviations).

[3] Free Cash Flow to Firm Valuation (40 points)

Your task as an equity analyst is to value the stock of Catalunya Oil Services with a Discounted Cash Flow to the Firm approach. Horizon is set at Year 10; the long-

term rate of growth of free cash flow is estimated at 2.50% in perpetuity, and the risk-free rate is 3.00%. The cost of equity is calculated with the CAPM model. The

bonds of the company are rated “A”. Sales are expected to grow at 7% from year 1 to 5 and at 3% from year 6 and beyond. COGS is 75% of sales; estimations for

depreciation charges, capital expenditures and the change in working capital are provided.

You need to estimate the WACC for the first 5 years of the valuation; it is assumed that it will be 8.00% in year 10 and beyond (you need to calculate its annual

decline from year 6 to 10). You will also need to calculate the discount factor for each year to arrive at present values.

Please calculate value of operating assets, value of the firm (with €3,750 million in non-operating cash), value of equity (debt is €11,330 million) and value per

share (with 1,251 million shares outstanding). The stock trades currently at €37.21/share in the equity market. Is it a BUY, a SELL, or a HOLD?

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