Practice Exam

Question 1

An analyst recently recommended that her client should participate in an auction for Eircom, an Irish
telephone company:
We estimate that Eircom will produce Earnings before Interest, Depreciation, Taxes and Amortization
(EBITDA) of €600M. Using a cost of equity of 10%, this results in a value for the equity of €6B
(assuming no growth in EBITDA). Adding the current level of debt €3.75B, we conclude that the
Eircom is worth almost €10B.

Name the 7 issues:

Answer 1

EBITDA approximates the cash flows available to both debt and equity holders. Therefore, discounting EBITDA
will result in a measure of enterprise value. One should subtract (not add) the debt to arrive at the value of
the equity. Other points:
a) The analyst has assumed no capital expenditure – this is likely to be significant for a telephone
company.
b) One should use a WACC rather than a cost of equity to arrive at enterprise value
c) It may be more appropriate to assume declining EBITDA since Eircom is primarily a landline company.
This will be related to the amount of CAPEX
d) The estimate of EBITDA may be incorrect
e) No allowance for taxes
f) The valuation is a perpetuity