TU Wien:Advanced Financial Planning and Control VU (Dangl)/Midterm Sample Exam

Problem 1

Consider a firm that shows the following historic accounting figures:

	2012	2013	2014
IC	30,000,000.00	?	?
Net Investment		4,200,000.00	5,000,000.00
ROIC		14.00%	14.00%
ROIC		?	?
ROIC		0.00	?

Please answer the following questions:

a) What was the firm’s net investment in 2013?

Already given ${\mbox{Net Invesmtent}}_{2013}=4,200,000$

b) What was the firm’s invested capital in 2013 and 2014?

We can use the fomular from slide 46 to calulate the invested capital in 2013 and 2014.
$IC_{2013}=IC_{2012}+{\mbox{Net Invesmtent}}_{2013}=30,000,000+4,200,000=34,200,000$
$IC_{2014}=IC_{2013}+{\mbox{Net Invesmtent}}_{2014}=34,200,000+5,000,000=39,200,000$

c) What was the firm’s NOPLAT in 2013 and 2014?

The NOPLAT can be calulated with the formular from slide 45.
${\mbox{NOPLAT}}_{2013}={\mbox{ROIC}}_{2013}\times IC_{2012}=14\%\times 30,000,000=4,200,000$
${\mbox{NOPLAT}}_{2014}={\mbox{ROIC}}_{2014}\times IC_{2013}=14\%\times 34,200,000=4,788,000$

d) What was the firm’s free cash flow in 2014?

Using the formular from slide 47 the fre cash flow of the year 2014 can be calulated as follows.
${\mbox{FCF}}_{2014}={\mbox{NOPLAT}}_{2014}-{\mbox{Net investment}}_{2014}=4,788,000-5,000,000=-212,000$

e) Assume in 2013 and 2014 the firm had capital costs of WACC = 12%. Did the firm create value in 2013 and 2014? How large was the creation/destruction of value in 2013 and 2014, respectively? Use the concept of economic profit to answer this question.

To dteremine if the firm created value we use the formular from slide 66 to calculate the Economic Profit, EP.
${\mbox{EP}}_{2013}={\mbox{NOPLAT}}_{2013}-({\mbox{WACC}}\times IC_{2012})=4,200,000-(12\%\times 30,000,000)=4,200,000-3,600,000=600,000$
${\mbox{EP}}_{2014}={\mbox{NOPLAT}}_{2014}-({\mbox{WACC}}\times IC_{2013})=4,788,000-(12\%\times 34,200,000)=4,788,000-4,101,000=684,000$

f) Assume that after 2014 the ROIC=RONIC of the firm declines to 12% while WACC is stable at 12% in the remaining future. What is the firm value at the end of year 2014?

If the firm ${\mbox{ROIC}}={\mbox{RONIC}}=12\%$ and ${\mbox{WACC}}=12\%$, the firm will achieve zero economic profit. Thus the value of the firm euqlas the invested capital at the end of 2014
${\mbox{Firm Value}}_{2014}=IC_{2014}+\sum _{t=2014+1}^{\infty }{\frac {{\mbox{EP}}_{t}}{(1+{\mbox{WACC}})^{t}}}=IC_{2014}+0=39,200,000$

Problem 2

Consider a firm with ROIC = RONIC = 15%. Its cost of capital are constant given by WACC = 20%. Invested capital at time t = 0 equals EUR 1,000,000.00. Please answer the following questions:

a) Assume the firm plans to grow at a rate of 15%. What is the firm’s Free cash flow at time t = 1 (FCF1)?

First we calculate the NOPLAT for $t=1$
$NOPLAT_{1}=ROIC\times IC_{0}=15\%\times 1,000,000=150,00$
Then we calculate the required investment rate (r)
$r={\frac {g}{ROIC}}={\frac {15\%}{15\%}}=100\%$
With those two value the Net Investment can be calculated
${\mbox{Net Investment}}_{1}=r\times NOPLAT_{1}=100\%\times 150,000=150,000$
And with the Net Investment the Free cash flow can be calculated
$FCF_{1}=NOPLAT_{1}-{\mbox{Net Investment}}_{1}=150,000-150,000=0$

b) Now assume the firm plans to grow at a rate of 10%. What is the firm’s Free cash flow at time t = 1 and what is the Economic profit at t = 1?

Recalulate the required investment rate (r)
$r={\frac {g}{ROIC}}={\frac {10\%}{15\%}}=66.67\%$
Calculate the Net Investment
${\mbox{Net Investment}}_{1}=r\times NOPLAT_{1}=66.67\%\times 150,000=100,000$
And with the Net Investment the Free cash flow can be calculated
$FCF_{1}=NOPLAT_{1}-{\mbox{Net Investment}}_{1}=150,000-100,000=100,000$
Finally calculate the Economic Profit:
$EP_{1}=NOPLAT_{1}-(WACC\times IC_{0})=150,000-(20\%\times 1,000,000)=150,000-200,000=-50,000$

c) Assume again a planned growth rate of 10%. What is the required investment rate?

Wae already calulated that in b)
$r={\frac {g}{ROIC}}={\frac {10\%}{15\%}}=66.67\%$

d) Assume again a planned growth rate of 10%. What is the time t = 0 firm value calculated as the sum of discounted Free cash flow?

Using the perpetual growth model for firm value from slide 83:
${\mbox{Firm Value}}={\frac {FCF_{1}}{WACC-g}}={\frac {50,000}{20\%-10\%}}={\frac {50,000}{10\%}}=500,000$

e) Is the firm creating value over its life time? What is the magnitude of value creation/destruction (= the net present value) at a growth rate of g = 10%?

The initial invested capital is $IC_{0}=1,000,000$. If we compare tthis with the firm value from d).
${\mbox{Net Value Creation}}={\mbox{Firm Value}}-IC_{0}=500,000-1,000,000=-500,000$
We see that the firm destroys value by $-500,000$

f) If the growth rate g has to be chosen between 0 and WACC, i.e., g ∈ [0, WACC), what is the value maximizing growth strategy of the firm?

To maximize value, the firm should select a growth rate $g$ that balances reinvestment with maximizing FCF. Since $ROIC<WACC$, increasing growth leads to value destruction. The optimal strategy is not to grow $(g=0)$, where FCF is maximized, and no additional value is destroyed.
$FCF=NOPLAT=150,000$
${\mbox{Firm Value}}={\frac {FCF}{WACC}}={\frac {150,000}{20\%}}=750,000$

Problem 3

Answer the following questions:

a) What is the definition of Return on new invested capital, RONIC? (be careful with the time-stamp of the accounting numbers).

Return on new invested capital, RONIC, measures the increase in operating income relative ot additionally invested capital, (Slide 46)
${\mbox{RONIC}}_{t}={\frac {\Delta {\mbox{NOPLAT}}_{t}}{\Delta {\mbox{Invested capital}}_{t-1}}}={\frac {\Delta {\mbox{NOPLAT}}_{t}}{{\mbox{Net investment}}_{t-1}}}$

b) What is the definition of Net Investment.

Net investment is the net increase in invested capital from one year to the next (Slide 46)
${\mbox{Net Investments}}_{t}=\Delta IC_{t}=IC_{t}-IC_{t-1}$

c) Is a negative Free cash flow at some time t a non-ambiguous signal of a badly managed firm (i.e., a firm that destroys value)? Give a detailed description of your arguments.

No, a negative FCF is not inherently a sign of poor management or value destruction. It depends on the firm's context and investment strategy.
When Negative FCF Can Be Positive:

• Growth Phase Firms:
  • Negative FCF may occur due to high net investments in profitable projects.
  • Example: Tech startups or companies entering new markets often have negative FCF but high growth potential.
• Strategic Investments:
  • Firms may intentionally reinvest earnings to expand capacity, launch new products, or enter new markets.
  • If the RONIC exceeds the WACC, these investments create long-term value.
• Cyclical Businesses:
  • Negative FCF may reflect temporary downturns in cash flow due to market cycles, not poor management.

When Negative FCF Indicates Poor Management:

• Low-Return Investments:
  • If investments yield a RONIC less than WACC, value is destroyed.
• Excessive Debt or Mismanagement:
  • Persistent negative FCF without a clear growth strategy can signal inefficiency or financial strain.

d) Is the following proposition correct (why / why not?): A firm with RONIC<ROIC should not plan to grow, because growth will certainly destroy value!

The proposition is incorrect. The relationship between RONIC and WACC, not RONIC and ROIC, determines value creation. Growth creates value if RONIC>WACC, even if RONIC<ROIC.