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University of California Irvine Understanding the Valuation Paper

University of California Irvine Understanding the Valuation Paper

Question Description

Instructions

This case study is based on a report written by two sell-side equity research analysts working for Credit SuisseFirst Boston Corporation. Such reports are typically used by investors to determine which stocks to invest in,and usually include a short overview of the industry, key financial estimates computed from the company’sfinancial statements, and a valuation. In this example, the company of interest is L3-Communications.

To complete this assignment, you will have to read through the report and answer the questions below. Notethat for several of the questions there are no strictly right or wrong answers. Instead, a good answer willprovide sound arguments based off clearly-stated assumptions and clearly-explained reasonings. Also, someof the numbers reported by the analysts may be a bit off compared to the calculations you may make. This ismostly due to rounding errors on their parts, so you should not worry about it.

Note that for parts 1 to 3, you should only use information contained in the report (i.e., you do not need to—and should not—look up extra information online).

Part 3 – Understanding the valuation

  1. 3.1. What is the 12-month-ahead share price predicted by the analysts?
  2. 3.2. How was this prediction made? More precisely, which ratio was used? What multiple was used? How doesthis multiple compare to that of 2001? What does it imply for the assumptions made by the authorsregarding the future growth of the company?
  3. 3.3. Had the authors made the valuation using P/E ratios, assuming a 2002 P/E ratio equal to the 2001 P/E ratio,what would the estimated 2002 share price have been?
  4. 3.4. Check that in 2000, the company’s debt to (book) equity ratio was 1.58. Assume that the company insteadhad had much less leverage, financing its operations with 50% less debt and making up the difference byissuing more shares. This would imply a new debt-to-equity ratio of 0.44. How many shares would then beoutstanding? How would P/E and EV/EBITDA multiples be impacted? What does it imply for the usefulnessof these multiples?

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