This case study is based on a report written by two sell-side equity research analysts working for Credit Suisse First 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’s financial 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. Note that for several of the questions there are no strictly right or wrong answers. Instead, a good answer will provide sound arguments based off clearly-stated assumptions and clearly-explained reasonings. Also, some of the numbers reported by the analysts may be a bit off compared to the calculations you may make. This is mostly 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

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How was this prediction made? More precisely, which ratio was used? What multiple was used? How does this multiple compare to that of 2001? What does it imply for the assumptions made by the authors regarding the future growth of the company?
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3.1. What is the 12-month-ahead share price predicted by the analysts?

3.2. How was this prediction made? More precisely, which ratio was used? What multiple was used? How does this multiple compare to that of 2001? What does it imply for the assumptions made by the authors regarding the future growth of the company?

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?

3.4. Check that in 2000, the company’s debt to (book) equity ratio was 1.58. Assume that the company instead had had much less leverage, financing its operations with 50% less debt and making up the difference by issuing more shares. This would imply a new debt-to-equity ratio of 0.44. How many shares would then be outstanding? How would P/E and EV/EBITDA multiples be impacted? What does it imply for the usefulness of these multiples?

Part 4 – Assessing the valuation

4.1. Look up L3-Communications historical stock prices around the date at which the report was written (the stock’s ticker is LLL). You should find a stock price roughly equal to half of the price you reported in question 1. How can you explain this discrepancy? (hint: to answer this question, you may have to do some extra research about the history of the company).

4.2. Look up L3-Communications’ stock price around May 2002. Report on the accuracy of the analysts’ 12- month-ahead price target, considering the change in scale mentioned above. Assuming that the authors’ EV and EBITDA estimates were correct, what multiples should they have used to make a correct 12-month -ahead prediction?

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