FIN 321-Midterm Exam - Quesrion 1

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Consider the valuation of Nike given in Example 10.1, in Chapter 10 
a.Suppose you believe Nike’s initial revenue growth rate will be between 7% and 11% (with growth always slowing linearly to 5% by year 2015). What range of share prices for Nike stock is consistent with these forecasts? 
b.Suppose you believe Nike’s initial revenue EBIT margin will be between 9% and 11% of sales. What range of share prices for Nike is consistent with these forecasts? 
c.Suppose you believe Nike’s weighted average cost of capital is between 9.5% and 12%. What range of share prices for Nike stock is consistent with these forecasts? 
 Cost of Capital         
  Year 200920102011######2015
FCF Forecast ($millions)         
2growth vs. prior year        
3EBIT  of sales       
4Less:  Income Tax of EBIT       
5Plus:  Depreciation         
6Less:  Capital Expenditures         
7Less:  Increase in NWC of Δ sales       
8Free Cash Flow         
9Terminal Value         
10PV of Free Cash Flows        
11Value of Cash         
12Value of Debt         
13Number of Shares         
14Share price         
a.If Initial Revenue Growth Rate can vary between 7 and 11%, the stock price can vary between      
b.If Initial Revenue EBIT Margin can vary between 9 and 11%, the stock price can vary between      
c.If Weighted Average Cost of Capital can vary between 9.5 and 12%, stock price can vary between      
d.Suppose that in January 2006,Nike had EPS of $3.51 and a book value of equity of $18.92 per share.   
  Book value of equity        
 a.Using the average P/E multiple in Table 10.1, estimate Nike’s
share price.
  Price per share        
 b.What range of share prices do you estimate based on the highest and lowest P/E multiples in Table 10.1?   
  Range based on highest to lowest      
 c.Using the average price to book value multiple in Table 10.1, estimate Nike’s share price.   
  Price per share        
 d.What range of share prices do you estimate based on the highest and lowest price to book value multiples in Table 10.1?   
  Range based on highest to lowest      
 Suppose that in May 2010, Nike had sales of $19,176 million, EBITDA of $2,809 million, excess cash of $3,500 million, $437 million of debt, and 485.7 million shares outstanding.   
  Shares outstanding        
 a.Using the average enterprise value to sales multiple in Table 10.1, estimate Nike’s share price.   
  Price per share        
 b.What range of share prices do you estimate based on the highest and lowest enterprise value to sales multiples in Table 10.1?   
  Range based on highest to lowest      
 c.Using the average enterprise value to EBITDA multiple in Table 10.1, estimate Nike's share price.   
  Price per share        
 d.What range of share prices do you estimate based on the highest and lowest enterprise value to EBITDA multiples in Table 10.1?   
  Range based on highest to lowest      
 Table 10-1      
 Stock Prices and Multiples for the Footwear Industry, January 2006      
 NameMarket Capitalization ($ millions)Enterprise Value ($ millions)P/EPrice/BookEnterprise Value/SalesEnterprise value/EBITDA   
 Adidas AG8,9508,55421.92.340.82#   
 Puma AG3,6802,98417.912.921.21#   
 Deckers Outdoor Corp.1,7601,40014.633.591.687   
 Skechers U.S.A.1,7301,42017.112.20.898   
 Wolverine World Wide1,4601,38018.723.081.229   
 Volcom, Inc.53145521.212.371.62#   
 Weyco Group28125220.241.741.11#   
 LaCrosse Footweara1189915.141.950.677   
 R.G. Barry Corp.1147911.111.960.635   
 Rock Shoes & Boots458925.960.560.385   


FIN 321-Midterm Exam - Quesrion 1            
You are a manager at Percolated Fiber, which is considering expanding its operations in synthetic fiber manufacturing. Your boss comes into your office, drops a consultant’s report on your desk, and complains, “We owe these consultants $1 million for this report, and I am not sure their analysis makes sense. Before we spend the $25 million on new equipment needed for this project, look it over and give me your opinion.” You open the report and find the following estimates (in millions of dollars):      
  Project Year       
 Sales revenue30,00030,000 30,00030,000       
  Cost of good sold18,00018,000 18,00018,000       
 = Gross profit12,00012,000 12,00012,000       
 – General, sales, and              
 administrative expenses2,0002,000 2,0002,000       
  Depreciation2,5002,500 2,5002,500       
 = Net operating income7,5007,500 7,5007,500       
  Income tax2,6252,625 2,6252,625       
 = Net income4,8754,875 4,8754,875       
All of the estimates in the report seem correct. You note that the consultants used straight-line depreciation for the new equipment that will be purchased today (year 0), which is what the accounting department recommended. The report concludes that because the project will increase earnings by $4.875 million per year for ten years, the project is worth $48.75 million. You think back to your halcyon days in finance class and realize there is more work to be done!      
First, you note that the consultants have not factored in the fact that the project will require $10 million in working capital upfront (year 0), which will be fully recovered in year 10. Next, you see they have attributed $2 million of selling, general and administrative expenses to the project, but you know that $1 million of this amount is overhead that will be incurred even if the project is not accepted. Finally, you know that accounting earnings are not the right thing to focus on!      
a.Given the available information, what are the free cash flows in years 0 through 10 that should be used to evaluate the proposed project?      
  Year 0Year 1Year 2Year 3Year 4Year 5Year 6Year 7Year 8Year 9Year 10 
 Cost of machine            
 Change in net working capital            
 Sales revenue            
 Minus cost of goods sold            
 Equals gross profit            
 Minus General, sales and administrative expense            
 Plus overhead that would have occurred anyway            
 Minus Depreciation            
 Equals net operating income            
 Minus income tax            
 Equals Net income            
 Plus depreciation            
 Cost of machine plus change in net working capital            
 Equals cash flow            
b.If the cost of capital for this project is 14%, what is your estimate of the value of the new project?      
 Cost of capital            
Chris Curtis was hired recently by Air World Transportation Inc., to assist the company with its financial planning and to evaluate the company’s performance. Chris graduated from college five years ago with a finance degree. He has been employed in the finance department of a Fortune 500 company since then.      
Air World Transportation (AWT) was founded 10 years go by two college engineers, John Saxton and Todd Parker. The Company has manufactured and sold light airplanes over this period and the company’s products have received high reviews for safety and reliability. The company has a niche market in that it sells primarily to individuals who own and fly their own airplanes. The company has two models; the Birdie, which sells for $53,000, and the Eagle, which sells for $78,000.      
Although the company manufactures aircraft, its operations are different from commercial aircraft companies. In contrast to commercial airplane companies that take one and one-half to two years to manufacture an airplane, the company can complete the manufacture of an airplane in only five weeks. Below are the financial Statements for 2012      
Air World Transportation Inc. 2012 Income Statement      
Other expenses3,867,500 
Taxable income$2,562,420 
Taxes (40%)1,024,968 
Net income$1,537,452 
Add to RE$977,452 
Air World Transportation Inc. 2012 Balance Sheet 
AssetsLiabilities & Equity
Current Assets Current Liabilities 
   Cash$441,000   Accounts Payable$889,000
   Accounts rec.708,400   Notes Payable2,030,000
   Inventory1,037,120      Total CL$2,919,000
      Total CA$2,186,520  
  Long-term debt$5,320,000
  Shareholder Equity 
Fixed assets    Common stock$350,000
  Net PP&E$16,122,400   Retained earnings9,719,920
        Total Equity$10,069,920
Total Assets$18,308,920Total L&E$18,308,920
Part I- Using the financial statements provided calculate each of the ratios listed in the table. Compare the performance of AWT to the industry. For each ratio, comment on why it might be viewed as positive or negative relative to industry.      
Current ratio0.75     
Quick ratio0.39     
Cash ratio0.15     
Total asset turnover1.67     
Inventory turnover21.43     
Receivables turnover43.05     
Total debt ratio0.45     
Debt-equity ratio0.82     
Equity multiplier1.82     
Times interest earned6.36     
Cash coverage ratio9.22     
Profit margin5.04%     
Return on assets8.40%     
Return on equity15.27%     
Part 2- After Chris completed the ratio analysis, he was asked to project pro forma financial statements for the next five years. The company had historically used little planning for investments and cash flow needs. As a result the company experienced some challenging times. The lack of planning also resulted in missed sales and inadequate cash flows for expansion.      
Chris was not sure about the growth rate of the company and at what rate sales will grow.      
Can you suggest how he should come up with a reasonable growth rate?      
Assume for planning proposes ATW will grow at 12 percent next year. Can the company’s sales increase at this rate?      
In financial planning, the assumption is that most assets can be increased as a percentage of sales. For instance, cash can be increased by the percentage of sales; however, fixed assets must be increased in specific amount because it is impossible, as a practical matter, to buy part of a new plant or machine. In this case, a company has a “staircase’ or ‘lumpy” fixed cost structure. Assume AWT is currently producing at full capacity (100 percent) and as a result, the company needs to set up an entire new line of production at a cost of $5,000,000. Calculate the new AFN with this assumption for 2013.      





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