Tom Davis, a recent UNO graduate, has been hired as a consultant to Goodluck Inc
ID: 2696690 • Letter: T
Question
Tom Davis, a recent UNO graduate, has been hired as a consultant to Goodluck Inc, a company that is seeking to increase its value. Goodluck asks him to estimate the value of a privately held company, Redfish Fishing Supplies (RFS), that it is considering acquiring. Tom obtains RFS's latest balance sheet and income statement as shown in Figure 1. Based on the historic record of the firm and the industry, he estimates that RFS's sales will grow by 15% annually in the next three years, and also compute a few ratios of RFS as shown in Figure 2. Figure 1. Financial Statements and Other Data (Millions except per share data) Balance Sheet, Hatfield, 12/31/12 Income Statement, Hatfield, 2012 Cash and securities $20 Sales $2,000 Accounts receivable 290 Total operating costs 1,600 Inventories 390 EBIT $400 Total current assets $700 Interest 60 Net fixed assets 500 EBT $340 Total assets $1,200 Taxes (40%) 136 Net income $204 Accounts pay. + accruals $100 Dividends $120 Notes payable 80 Add. to retain. earnings $84 Total current liabilities $180 Shares outstanding 10 Long-term debt 520 EPS $20.40 Total liabilities $700 DPS $12.00 Common stock 300 Year-end stock price $204.00 Retained earnings 200 Total common equity $500 Total liab. & equity $1,200 Figure 2. Selected Ratios of RFS, 2012 Selected Ratios and Other Data 2012 Sales, (S0): $2,000 Expected growth in sales: 15.0% Profit margin (M): 10.2% Assets/Sales (A0*/S0): 60.0% Payout ratio (POR): 58.8% Equity multiplier (Assets/Equity): 2.40 Total liability/Total assets 58.3% Times interest earned (EBIT/Interest): 6.67 (Payables + Accruals)/Sales (L0*/S0): 5.0% Operating costs/Sales: 80.0% Cash/Sales: 1.0% Receivables/Sales: 14.5% Inventories/Sales: 19.5% Fixed assets/Sales: 25.0% Tax rate: 40.0% Interest rate on all debt: 10.00% Price/Earning (P/E): 10.0 ROE (Net income/Common equity): 40.80% 1. Forecast Financial Statements Tom decides to, as a first step, forecast RFS's financial statements for the next three years. The forecasting will be based on the following assumptions. (1) Operating ratios remain unchanged. (2) When additional financing is needed, the firm will issue common stock. Notes payable and long-term bonds will be issued only to replace the existing debt securities. This assumption is made because RFS's executives have lately expressed concerns about the firm's debt ratio being considerably higher than the industry average; the CFO has indicated that the firm is planning to add no debt to its balance sheet in the foreseeable future. (3) The interest rate on all debt is 10%. (4) Regular dividends will grow by 15% annually. (5) Sales will grow by 15% annually. Forecast the Balance Sheets and Income Statements for RFS in fiscal year 2013, 2014, and 2015. [5'] Inputs for Forecasts RFS 2012 Sales growth rate 15.0% Operating costs/Sales 80.0% Cash/Sales 1.0% Receivables/Sales 14.5% Inventories/Sales 19.5% Fixed assets/Sales 25.0% Payables and accruals/ Sales 5.0% Growth rate in regular dividends 15.0% Interest rate on all debt 10.0% Tax rate 40.0% 2. Free Cash Flows and Ratio Analysis To have a better understanding about RFS's prospects, Tom decides to conduct ratio analysis and also compute its free cash flow (FCF) and additional funds needed (AFN). Work out the table below for Tom. [3'] RFS 2012 Forecasted Performance 2013 2014 2015 Net operating profits after taxes Net operating working capital Total operating capital Free cash flow AFN EPS DPS Payout ratio Profit margin Sales/Assets (Assets turnover) ROE Total liability/Total assets TIE ratio 3. Estimate the Corporate Value The key of this project is to estimate the value of RFS as Goodluck Inc. is considering making a tender offer to RFS's current shareholders. Tom has estimated the weighted cost of capital of RFS is 10%, and he assumes the firm's EBIT will grow at a constant rate of 5% annually after year 2015. Based on the corporate valuation model, what is the intrinsic value per share of RFS? [5']Explanation / Answer
Definition of 'Earnings Before Interest & Tax - EBIT' An indicator of a company's profitability, calculated as revenue minus expenses, excluding tax and interest. EBIT is also referred to as "operating earnings", "operating profit" and "operating income", as you can re-arrange the formula to be calculated as follows: EBIT = Revenue - COGS- Operating Expenses - Depreciation & Amortization Also known as Profit Before Interest & Taxes (PBIT), and equals Net Income with interest and taxes added back to it. Investopedia explains 'Earnings Before Interest & Tax - EBIT' In other words, EBIT is all profits before taking into account interest payments and income taxes. An important factor contributing to the widespread use of EBIT is the way in which it nulls the effects of the different capital structures and tax rates used by different companies. By excluding both taxes and interest expenses, the figure hones in on the company's ability to profit and thus makes for easier cross-company comparisons. EBIT was the precursor to the EBITDA calculation, which takes the process further by removing two non-cash items from the equation (depreciation and amortization).