BKAF 3073 2014

Case I : Green Berhad

EXECUTIVE SUMMARY
In Case No.1, Green Berhad is considering an investment in Alam Sdn Bhd, a
new joint venture company wishes that established at the end of year 2013. It is a way
to obtained extra profit to the company as the investment will pay them back with
dividend but it also comes with risk that Mr Najib Abdullah need to consider before
investing in Alam Sdn Bhd.
To compute the value of the equity of the Alam Sdn Bhd, we use the Present
Value instead of Present Value of Ordinary Annuity. The reason we choose Present
Value is due to we are doing forecasting in price of the share in order to make
decision to invest in Alam Sdn Bhd which is more suitable than the Present Value of
Ordinary Annuity. We use the abnormal earning valuation model. The value of equity
for Alam Sdn Bhd is the sum of the present value of expected future abnormal
earnings and beginning book value of asses.
We need to determine Alams intrinsic price-to-earnings (P/E) ratio. In order to
do that, we use formula value per share divided to EPS. The purpose is to determine
how much the investor is willing to pay for every RM current earnings by the
company. We also want to see the expected growth by the investor in future compare
on what had been forcasted by Green Bhd.
We will recommend to Mr Najib Abdullah to not invest in the Alam Sdn Bhd as
the investment will not benefit Green Berhad
The purpose of all the calculations above is to look of potential of Alam Sdn
Bhd. From that , we can recommend to Mr Najib Abdullah in order to make a decision
whether they want to invest in Alam Berhad or not.

BKAF 3073 2014

Case No.1
Question 1
Comment on how the Free Cash Flow spreadsheet calculation compares with how
accountants and auditors might compute free cash flow directly from the companys
financial statements.
2014

2015

2016

2017

2018

2019

2020

RM 2034

RM 2130

RM 2218

RM 2256

RM 2278

RM 2404

RM 2546

Beginning
of
book
RM 6300
value of net
asset

RM 6290

RM6830

RM 7330

RM 7220

RM 8260

RM 8850

10%

10%

10%

10%

10%

10%

RM 629

RM 683

RM 733

RM 722

RM 826

RM855

RM 1501

RM 1535

RM 1523

RM 1556

RM 1578

RM 1661

Net Income

Required
Rate
of
10%
Return
Required
normal
RM 630
earnings
Expected
future
RM 1404
abnormal
earnings

1.

Forecast expected future abnormal earnings

Present value of expected future abnormal earnings

Expected
future
abnormal
earnings

2014

2015

2016

2017

2018

2019

2020

RM 1404

RM 1501

RM 1535

RM 1523

RM 1556

RM 1578

RM 1661

0.82645

0.75131

0.68301

0.62092

0.56447

0.51316

RM 1241

RM 1153

RM 1040

RM 966

RM 891

RM 852

Present
0.90909
value factor
Present
value
of
RM 1276
each future
abnormal
earnings

BKAF 3073 2014

Sum of all present values

RM 7,419

Beginning equity book

value

RM 6,300

Value of business
opportunity

RM 13,719

Value per share = RM 13.71

Expected abnormal earnings beyond year 2020
Abnormal earning

1,661

Residual earning grow rate

1.06

Expected abnormal earning

1,760.66

Perpetuity factor[1/(0.1 0.06)]

25
44,016.50

Present value factor

0.51316

Present value of terminal value

22,587.51

RM
Beginning book value

6,300

Sum of all present value

7,419

Present value of terminal value

22,587.51

Value of equity Alam Sdn Bhd

36,306.51

BKAF 3073 2014

Question 2
Determine Alams intrinsic price-to-earnings (P/E) ratio. Assuming the actual marketbased P/E ratio is 20, provide your recommendations about this company in
comparison to the intrinsic P/E ratio.

Alams intrinsic price-to-earnings ratio (P/E ratio)

Value per share / EPS
= 36,306.51 / 2,034
= 17.85
It is mean that investor are willing to pay RM 20 for every RM current earnings by the
company. But it is show that Alams intrinsic price-to-earnings ratio is 17.85 which is
mean that the investor is expecting higher growth in the future compare on what had
been forcasted by Green Bhd and willing to pay more for every RM 1 earnings of the
company.

BKAF 3073 2014

Case II : CeasTECH Solutions Berhad
EXECUTIVE SUMMARY
In Case two we are required to discuss in detail regarding discounted cash flow
valuation of CeasTECH.
Cash flow valuation is a valuation method used to estimate the attractiveness of an
investment opportunity. It uses the future free cash flow projections and discounts
them to arrive at a present value, which is then used to evaluate the potential for
investment. If the value is higher than the current cost of investment that means that
the opportunity is good for the company.
CeasTECH Solutions Berhad develops digital media products, services, and
technologies for consumers and content development professionals. In our case
study, it is assumed that the stock is valued at RM13 per share, Current market price
for stock is RM8.71, Weighted average cost of capital of 12% and a Perpetual growth
rate of 5%..
Based on case 2, we have been given several information for CeasTECH Solutions
Berhad. Apart from that, we need to comment on how free cash flow spreadsheet
calculation compares with how accountants and auditors might compute free cash
flow. We determine it by compare the spreadsheet with actual annual report and see
the difference in terms of calculation of cash flow. We also need to identify annual
rate of growth in forecasted sales and free cash flow for each year given. We identify
it by using formula and comment the amount by see the percentage on that amount.
Besides, we also determine the role of WACC in discounted cash flow valuation
analysis. We identify it by make some calculation. Moreover, we also need to
comment on present value calculation. We identify it by looking at the spreadsheet
and make some calculation. Then, we need to identify why analyst subtract an amount
for net debt in arriving at equity value. We identify it by doing some calculation. Then
we need to analysis amount on share value.
The actions that we are going to recommend to the CeasTECH Solution Berhad and
Kencana Finance House is that the both companies needs to communicate with each
other regarding which method to be used in computing the share value. Because of
the lack of communication and teamwork between these 2 companies for preparing
the free cash flow statement brings the difference in result.

BKAF 3073 2014

CASE NO.2

Question 1
Comment on how the Free Cash Flow spreadsheet calculation compares with how
accountants and auditors might compute free cash flow directly from the companys
financial statements
The computation of Free Cash Flow spreadsheet is by determines the EBITDA.
EBITDA is used to analyse and compare profitability between companies and
industries because it eliminates the effects of financing and accounting decisions.
EBITDA also non-GAAP measure that allows a greater amount of discretion as to what
is (and is not) included in the calculation. This also means that companies often
change the items included in their EBITDA calculation from one reporting period to
the next. After obtain the amount of EBITDA, the amount will subtract with capital
expenditures and cash taxes to get free cash flow.
While, the computation of Free Cash Flow for companies financial statement is by
compute the cash flow from operation (operating cash) minus capital expenditure.
But, to do it another way, look to the income statement and balance sheet. Start with
net income and add back charges for depreciation and amortization. Make an
additional adjustment for changes in working capital, which is done by subtracting
current liabilities from current assets. Then subtract capital expenditure (or spending
on plants and equipment).

BKAF 3073 2014

QUESTION 2
Compute the annual rate of growth in forecasted sales and free cash flow for each
year (2014 through 2021). Comment on the relative rates of sales and free cash flow
growth.

Formula: Annual Rate of Growth:

2014
Forecasted

2015

2016

24.57% 70.67% 48.06%

2017

2018

2019

2020

2021

72.96% 15%

15%

15%

15%

Sales
Free Cash 17.95% 82.61% 107.14% 94.25% 17.46% 27.46% 31.62% 19.82%
Flow

Computation:
Year

Forecast sale

Free cash flow

2014
2015
2016

2017
2018

2019
2020
2021

BKAF 3073 2014

Comment:
Free Cash Flow depends on sales because to get free cash flow, we need to use
EBITDA. In calculation of EBITDA, the formula is sales minus expenses. EBITDA will
be high if sales is high, then it also effect the free cash flow which is free cash flow
will become increases. Apart from the calculation also, we can identify on how many
revenues will change to cash. This can be identified by the percentage of the forecast
sales and free cash flow that have been computed. The higher the percentage of sales
and free cash flow, the higher the probability of revenues that will change to cash.

Question 3
What role does the 12% weighted average cost of capital assumption play in the
discounted cash flow valuation analysis?
Weighted Average Cost of Capital (WACC) is used in discounting cash flows for
calculation of NPV and other valuations for investment analysis. WACC represents
the average risk faced by the organization. It would require an upward adjustment if it
has to be used to calculate NPV of project which are more risk than the company's
average projects and a downward adjustment in case of less risky projects.
For the CeasTECH Solutions Berhad, the 12% will determine how much the company
get went they make an investment. But, if the company's return is less than WACC,
the company is shedding value, which indicates that investors should put their money
elsewhere. The 12% WACC also will help the company to decide whether to invest or
not because WACC will present the minimum rate of return at which company
produce for the investor.

BKAF 3073 2014

Question 4
Write a brief paragraph explaining to someone unfamiliar with present value
calculations how the figure RM155.19 for Present value 20142021 is computed.
Present value is a future amount of money that has been discounted to reflect its
current value, as if it existed today. The formula to get present value is;

Where FV is the future amount of money that must be discounted,

is the number of

compounding periods between the present date and the date where the sum is worth
FV , r is the interest rate for one compounding period (the end of a compounding
period is when interest is applied, for example, annually, semi-annually, quarterly,
monthly, daily). The interest rate r, is given as a percentage, but expressed as a
decimal in this formula.
CeasTECH also used the same formula above to calculate PV. The calculations of PV
for year 2014 until 2021 are shown below in the table 1.1 and it has been simplified.
After get the PV for each year, from 2014 until 2021, CeasTECH make sum all the PV
for each year to get that amount which is RM155.19. That is how CeasTECH calculate
the amount.

Table 1.1

Year

Present value

2014

4.6(0.893)=4.11

2015

8.4(0.797)=6.7

2016

17.4(0.711)=12.38

2017

33.8(0.636)=21.48

2018

39.7(0.567)=22.53

2019

50.6(0.5070)=25.64

2020

66.6(0.452)=30.13

2021

79.8(0.404)=32.23

Total of present value 155.2

BKAF 3073 2014

Question 5
Explain how the figure RM460.43 for Present value beyond 2021 is computed.
The first step to determine the figure RM460.43 for present value beyond 2021 is by
identifies the terminal value (TV). It refers to the value of the company at the end of
the forecasting period. In order to identify that, we need to use free cash flow, WACC
and perpetual growth rate. All of this has been given in the spreadsheet. The
calculations are as below:

=RM1, 140.00

Once TV has been determined, we calculate the Discounted Rate in order to determine
the Present Value of Terminal Value. The calculations are as below:

=RM 460.43

Based on the calculation above, RM1140 is from the terminal values that have been
computed, while the 0.12 is the WACC percentage and the n=8 are referring to year
from 2014 until 2021.

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BKAF 3073 2014

Question 6
Why does the analyst team subtract an amount for net debt in arriving at Equity
value? (Note: The term net debt is defined for spreadsheet purposes as financial
liabilities (e.g., loans) minus any financial assets (e.g., money market investments)
and is negative in the spreadsheet because CeasTECHs financial assets exceed its
financial liabilities.)
The analyst team subtract an amount for net debt in arriving at equity value. The
amount of RM615.6 million is representing enterprise value which is the value of a
companys net operating assets. So, to get equity value, CeasTECH Berhad needs to
subtract their net operating assets with net debt. The method used by the analyst
(Discounted Cash Flow Valuation), the result of adding all the present value for the
future cash flow forecasted and also the Terminal Value RM 615.60 is actually show
the value of the business as whole. Furthermore, as CeasTECH forecast earnings
growth for the firm, they generally assume that it will increase debt as it grows. So,
they no need to subtract out the value of these future debt issues when estimating
equity value today because it is a current value and these future claims do not exists
today.

Enterprise value Net debt = Equity value

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BKAF 3073 2014

Question 7
What share value estimate would the Kencana Finance House team have calculated if
they had used an? Why?
2014

RM

Expected future value(net income)

137.4

Required (normal) earnings:

beginning equity book value

672.1

Investors required rate of return (%)

12

required normal earnings

80.652

Expected future abnormal earnings

56.75

Expected future abnormal earnings

56.75

present value factor

4.11

-present value factor of abnormal earnings

52.64

Equity value

672.1

share outstanding

52.64

share value

12.77

If using an abnormal earnings value approach, the estimate share value of Kencana
Finance House team is RM12.77. In general, abnormal earnings value approach and a
discounted cash flow approach should give the same equity value but for this case,
theres different between both approached.
The major difference between the two approaches is:
a) Abnormal earnings valuation recognizes that the accrual process may already
have performed a portion of the task.
b) The discounted cash flows approach moves back to the primitive cash flows
underlying the accruals.
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BKAF 3073 2014

Question 8
8) Sometimes analysts research reports contain inadvertent computational errors.
What would the estimated value of CeasTECHs stock have been if the Kencana
Finance House team mistakenly used 34.60 million shares outstanding rather than the
correct 51.69 million share count?
The estimated value of of CeasTECHs stock have been if the Kencana Finance House
team mistakenly used 34.60 million shares outstanding rather than the correct 51.69
million share count is as calculated below;
Value of price per shares
1) Correct Equity Value

2) Incorrect Equity Value

= 51.69 million

= 34.60 million

672.1m34.6m shares
= RM 19.42 per shares

Current market price of RM8.71

If Kencana Finance House mistakenly used 34.6 million shares.
The estimated value of CeasTeach will be RM10.72 (RM 19.42 RM 8.71).
If Kencana Finance House use the correct shares, which is rm51.69m million.
The estimated value will be RM 4.29 (RM 13 - RM 8.71).
This computation mistake will affect the decision making of the investors whether
they want invest or not and the research report will provide an inaccurate information
that may influence the entitys reputation and images. So, if the CeasTECHs have
been mistakenly recorded the number of share outstanding, the shareholders can
expect their return in the future because the errors are higher than the expected. The
high estimated share value will lead to the meaning of the share is more valued
compare to the actual value of the share. The users will be overvalued the share
value. This mistaken number of share creates misunderstanding as the information
incorrect. Thus, wrong report analysis lead to wrong decision making and this
wrongness also can affect the organization.
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BKAF 3073 2014

REFERENCES
1. Definition

of

Discounted

Cash

Flow.

Retrieved

from

<http://www.investopedia.com/terms/d/dcf.asp>

2. Definition

of

Abnormal

Earnings

Valuation

Model.

Retrieved

from

<http://www.investopedia.com/terms/a/abnormal-earnings-valuation-model.asp>
3. Lawrence Revsine (2012). Financial reporting and Analysis (5th Edition). The Role of
Financial Information in Valuation, Cash Flow Analysis, and Credit Risk Assessment.
McGraw-Hill. New York.

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