Tim Reynolds, CFA, works for an investment research firm that is currently in the process of analyzing the global marine products industry. Reynolds’ supervisor, Mike Lapke, CFA, expects there to be significant consolidation among the 50 firms in the marine products industry as a result of mergers among its smaller firms. Lapke is particularly interested in how the expected consolidation activity will affect the five largest firms within the industry, which include two U.S. companies, two British companies, and one Japanese firm.

The two U.S. firms are U.S. Marine, Inc., and Atlantic Coastal Products, Inc. The British firms are Royal Crown Industries, LTD and Liontrust, PLC, and the Japanese firm is Bandai Oceanographic Industries, LTD. Currently the total worldwide revenue for this industry is $640 billion. Lapke has collected data for the five firms identified above along with more detailed data of two U.S. firms that he is following more closely.

Company	Revenue (in billions)
U.S. Marine, Inc. (USM)	$64.7
Atlantic Coastal Products, Inc (ACP)	$50.0
Royal Crown Industries, LTD	$45.6
Liontrust, PLC	$37.5
Bandai Oceanographic Ind. , LTD	$18.0

Selected financial data (in billions):

	USM Inc.	ACP Inc.
Sales	$64.70	$50.00
EBIT	9.68	6.00
EBT	7.75	5.84
NI	4.36	4.20
Assets	95.40	73.36
Equity	21.90	28.47
Payout Ratio	0.45	0.65
Required rate of return (r)	15%	11%

The three-firm and five-firm concentration ratios are closest to:

Three-firm

Five-firm

A) 74.28% 100.00%

B) 25.05% 33.72%

C) 33.72% 74.28%

The tangible price-to-earnings (P/E) and franchise P/E values for ACP, Inc. are closest to:

Tangible P/E

Franchise P/E

A) 4.59 6.67

B) 6.67 4.59

C) 9.09 2.08

Lapke is concerned that the marine products industry may be near full capacity. With this in mind, Lapke asked Reynolds to estimate capacity utilization for the industry based on the manufacturing demand forecast presented below.

Projections for the year ending:	2008	2009	2010
Available capacity (in 100,000 units)	450	492	496
Expected demand (in 100,000 units)	275	308	360

Based on his forecasts, the industry capacity utilization for 2008 and 2010 is closest to:

2008

2010

A) 62.60% 72.58%

B) 61.11% 72.58%

C) 72.58% 61.11%

During his research, Reynolds has observed that many of the firms in the marine products industry are concerned about the impact that new technology will have on their future profitability. Specifically, these firms are afraid that the competition resulting from new technologies will reduce their market share. Based on this observation, what stage of the industry life cycle are the firms in the marine products industry most likely in?

A) Growth.

B) Mature.

C) Decline.

In addition to evaluating the five largest firms in the marine products industry, Lapke has asked Reynolds to conduct a valuation of a smaller firm, one that is domiciled in an emerging market. They both agree that the emerging market firm’s value should be estimated as the present value of the company’s expected future free cash flows discounted at the appropriate weighted average cost of capital. They do not, however, agree on the appropriate method for incorporating country risks into the analyses. Lapke believes that the discount rate should be adjusted to reflect country risk, but Reynolds holds the opinion that cash flows should be adjusted. During their discussion, the following two statements are made.

Reynolds' comment:	The evidence on this issue suggests that country risks are best incorporated into the valuation process by adjusting the cash flows in a scenario analysis rather than including them in the discount rate.
Lapke's comment:	Regardless of whether we adjust the discount rate or the cash flows to reflect emerging market risk, both the nominal and real cash outflow associated with net working capital should be computed as the change in nominal and real cash outflow from net working capital, respectively.

With respect to these statements:

A) both are correct.

B) only Lapke is correct.

C) only Reynolds is correct.

Wavington Enterprises is headquartered in an emerging market nation that is expected to have 27% inflation over the next year. Charleston Johnson expects the local government to be successful in bringing inflation under control, and anticipates that it will fall to 20% in the second year and 10% in the third year, where he expects inflation to stabilize. Johnson predicts that by year 3, Wavington will have nominal free cash flow of $187 million growing at 4% annually in real terms. In view of his optimistic outlook, he is considering an investment in Wavington, and has calculated the real WACC for Wavington at 8%. The nominal continuing value of Wavington in year 3 is closest to:

A) $4,862.

B) $4,675.

C) $4,250.

Wavington Enterprises is headquartered in an emerging market nation that is expected to have 27% inflation over the next year. Charleston Johnson expects the local government to be successful in bringing inflation under control, and anticipates that it will fall to 20% in the second year and 10% in the third year, where he expects inflation to stabilize. Johnson asserts that the financial ratios of Wavington will be the same in both the real and nominal approaches. With regard to this statement, Johnson is:

A) correct because the underlying operations of the firm are unaffected by valuation methodology.

B) incorrect because cash flow forecasts in real terms are generally more accurate than cash flow forecasts in nominal terms.

C) correct because the rate of inflation used in calculating the components of financial ratios is the same for all components.