1. You have been asked to compare two banks – Suntrust Banks and Southwest Banks. Suntrust has a market value of equity of $ 1.5 billion, a book value of equity of $ 750 million, and is expected to earn 20% as its return on equity. Southwest Banks has a market value of equity of $ 1.00 billion and a book value of equity of $ 750 million. Both firms are in stable growth, growing at 5% a year, and the same cost of equity.
a. Assuming that Suntrust is co
ectly valued by the market, estimate the cost of equity for the bank. (15 points)
. Using the cost of equity estimated in part a, estimate the return on equity that Southwest Banks is expected to earn in the future. (You can assume that Southwest Banks is co
ectly priced as well XXXXXXXXXXpoints)
2. You have been asked to assess the value of synergy in an acquisition of Nuevos Fashion, a children’s apparel firm, by Fitch and Spitzer, a general apparel firm. You are supplied with the following information on the two firms.
• Nuevos Fashion earned an after-tax operating margin of 8% on its revenues of $ 1000 million last year, and its sales to capital ratio was 2. The cost of capital is 10%.
Fitch and Spitzer earned an after-tax operating margin of 10% on its revenues of $2250 million and its sales to capital ratio was 2.5. The dollar cost of capital is 10%.
You can assume that both firms would be in stable growth as independent companies, growing 5% a year.
a. Value Nuevos Fashion as an independent firm. ( 15 points)
. Value Fitch and Spitzer as an independent firm. (15 points)
c. Now assume that the primary motive behind the merger is Fitch and Spitzer’s
elief that they can run Nuevos more efficiently and increase its sales to capital ratio
and margin to match their own. Assuming that the growth rate remains unchanged at
5%, estimate the value of control in this merger. (30 points)
3. You have been called in by LaPlace Instruments, a manufacturer of medical equipment, to provide some advice on value creation. The firm has a market value of $ 525 million and you believe that it is fairly priced. The firm reported EBITDA of 150 million in the most recent financial year and paid 40% of its income as taxes. The firm also had capital expenditures of $ 75 million, depreciation of $ 25 million, and no working capital needs during the year. The firm has an expected growth rate of 4%. You believe that the firm can double its return on capital on new investments but cannot do much to improve its return on capital on existing investments. Estimate the value of the firm with this change, assuming that the stable growth rate remains 4%. ( 10 points)
• Fitch and Spitzer earned an after-tax operating margin of 10% on its revenues of $2250 million and its sales to capital ratio was 2.5. The dollar cost of capital is 10%.
You can assume that both firms would be in stable growth as independent companies, growing 5% a year.
a. Value Nuevos Fashion as an independent firm. ( 15 points)
. Value Fitch and Spitzer as an independent firm. (15 points)
c. Now assume that the primary motive behind the merger is Fitch and Spitzer’s
elief that they can run Nuevos more efficiently and increase its sales to capital ratio
and margin to match their own. Assuming that the growth rate remains unchanged at
5%, estimate the value of control in this merger. (30 points)
• Fitch and Spitzer earned an after-tax operating margin of 10% on its revenues of $2250 million and its sales to capital ratio was 2.5. The dollar cost of capital is 10%.
You can assume that both firms would be in stable growth as independent companies, growing 5% a year.
a. Value Nuevos Fashion as an independent firm. ( 15 points)
. Value Fitch and Spitzer as an independent firm. (15 points)
c. Now assume that the primary motive behind the merger is Fitch and Spitzer’s
elief that they can run Nuevos more efficiently and increase its sales to capital ratio
and margin to match their own. Assuming that the growth rate remains unchanged at
5%, estimate the value of control in this merger. (30 points)
3. You have been called in by LaPlace Instruments, a manufacturer of medical equipment, to provide some advice on value creation. The firm has a market value of $ 525 million and you believe that it is fairly priced. The firm reported EBITDA of 150 million in the most recent financial year and paid 40% of its income as taxes. The firm also had capital expenditures of $ 75 million, depreciation of $ 25 million, and no working capital needs during the year. The firm has an expected growth rate of 4%. You believe that the firm can double its return on capital on new investments but cannot do much to improve its return on capital on existing investments. Estimate the value of the firm with this change, assuming that the stable growth rate remains 4%. ( 10 points)