FIN 321-Midterm Exam - Quesrion 1

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Question 1

	FIN 321-Midterm Exam - Quesrion 1
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?

	Nike
	Cost of Capital

		Year		2009	2010	2011	2012	2013	2014	2015
FCF Forecast ($millions)
1	Sales
2	growth vs. prior year
3	EBIT		of sales
4	Less: Income Tax		of EBIT
5	Plus: Depreciation
6	Less: Capital Expenditures
7	Less: Increase in NWC		of Δ sales
8	Free Cash Flow
9	Terminal Value
10	PV of Free Cash Flows
11	Value of Cash
12	Value of Debt
13	Number of Shares
14	Share price

a.	If Initial Revenue Growth Rate can vary between 7 and 11%, the stock price can vary between
						and

b.	If Initial Revenue EBIT Margin can vary between 9 and 11%, the stock price can vary between
						and

c.	If Weighted Average Cost of Capital can vary between 9.5 and 12%, stock price can vary between
						and
d.	Suppose that in January 2006,Nike had EPS of $3.51 and a book value of equity of $18.92 per share.

		EPS
		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
		High
		Low

	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
		High
		Low

	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.

		Sales
		EBITDA
		Cash
		Debt
		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
		High
		Low

	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
		High
		Low

	Table 10-1
	Stock Prices and Multiples for the Footwear Industry, January 2006
	Name	Market Capitalization ($ millions)	Enterprise Value ($ millions)	P/E	Price/Book	Enterprise Value/Sales	Enterprise value/EBITDA
	Adidas AG	8,950	8,554	21.9	2.34	0.82	11.08
	Puma AG	3,680	2,984	17.91	2.92	1.21	11.48
	Deckers Outdoor Corp.	1,760	1,400	14.63	3.59	1.68	6.94
	Skechers U.S.A.	1,730	1,420	17.11	2.2	0.89	8.37
	Wolverine World Wide	1,460	1,380	18.72	3.08	1.22	9.28
	Volcom, Inc.	531	455	21.21	2.37	1.62	12.64
	Weyco Group	281	252	20.24	1.74	1.11	10.75
	LaCrosse Footweara	118	99	15.14	1.95	0.67	6.54
	R.G. Barry Corp.	114	79	11.11	1.96	0.63	4.64
	Rock Shoes & Boots	45	89	25.96	0.56	0.38	5.45
			Average	18.393	2.271	1.023	8.717
			Maximum	41%	58%	64%	45%
			Minimum	-40%	-75%	-63%	-47%

Question 2

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
		1	2	…	9	10
	Sales revenue	30,000	30,000		30,000	30,000
	– Cost of good sold	18,000	18,000		18,000	18,000
	= Gross profit	12,000	12,000		12,000	12,000
	– General, sales, and
	administrative expenses	2,000	2,000		2,000	2,000
	– Depreciation	2,500	2,500		2,500	2,500
	= Net operating income	7,500	7,500		7,500	7,500
	– Income tax	2,625	2,625		2,625	2,625
	= Net income	4,875	4,875		4,875	4,875
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 0	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7	Year 8	Year 9	Year 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
	NPV

Question 3

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
Sales		$30,499,420
COGS		22,224,580
Other expenses		3,867,500
Depreciation		1,366,680
EBIT		$3,040,660
Interest		478,240
Taxable income		$2,562,420
Taxes (40%)		1,024,968
Net income		$1,537,452
Dividends		$560,000
Add to RE		$977,452
Air World Transportation Inc. 2012 Balance Sheet
Assets			Liabilities & Equity
Current Assets			Current Liabilities
Cash	$441,000		Accounts Payable	$889,000
Accounts rec.	708,400		Notes Payable	2,030,000
Inventory	1,037,120		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 earnings	9,719,920
			Total Equity	$10,069,920
Total Assets	$18,308,920		Total 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 ratio	0.75
Quick ratio	0.39
Cash ratio	0.15
Total asset turnover	1.67
Inventory turnover	21.43
Receivables turnover	43.05
Total debt ratio	0.45
Debt-equity ratio	0.82
Equity multiplier	1.82
Times interest earned	6.36
Cash coverage ratio	9.22
Profit margin	5.04%
Return on assets	8.40%
Return on equity	15.27%

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.