EMBA602-Capital Allocation and Valuation
1. This problem requires you to estimate the WACC of a real company using publicly available data as of the fall of 2019. The company is Home Depot (Ticker: HD). You need to collect information as directed below. Here are the sources for the various data:
Look up market data on any recent day (unless otherwise specified) and use those in your calculations. Assume that the market value of debt is equal to its book value and that the tax rate is 25%. No need for any size adjustments. Problem Intent: To compute WACC of a company from published data.
Some of the data for following problems are provided in a separate spreadsheet on Canvas.
2. This problem is intended to show you the relation between free cash flows that we derive using the template for financial analysis and the accounting cash flow statement. Working out a problem will clarify the issue in a way no amount of lectures and explanations can.
We will do this at the company level. The key difference is that the free cash flow is the cash flow generated by the company’s operations after reinvesting in capital expenditure and working capital for the future but before any payouts are made to capital providers. Payouts to stockholders include dividends or stock repurchases, payouts to creditors include interest (and its tax effect) and principal payments. “Additions to Cash” is the cash left over after payouts to capital providers.
The accounting cash flow statement of a company for 20xx is provided in a separate spreadsheet. In addition, interest earnings from short-term investments and interest expense from debt (both from income statement) are provided. You may assume the tax rate for this problem as 25%. Estimate the expected free cash flow for 20xx using this statement. In your answer, clearly indicate the following:
Operating cash flow Free
Problem Intent: To illustrate the link between accounting Statement Cash Flows and Free Cash Flow Template
3. Home Depot’s year-ending financial statements for 2018 & 2019 are provided in a separate spreadsheet. Some additional information, such as number of shares outstanding and share prices are also provided for the same dates. Notes are provided in the spreadsheet to help you classify certain balance sheet items (when it is unclear) as either financial or operational. You need to classify the others by yourself.
a. Construct end-of-year economic balance sheets for 2018 and 2019 based on market data provided.
b. Calculate the FCF for 2019. Assume profit from asset sale is zero.
c. What perpetual growth in free cash flows (FCF) does the market price of Home Depot imply? For uniformity, use a long-run WACC of 8.0% for Home Depot, which is consistent with a long-run risk-free rate of 3-4%. Note that 2019 FCF will be the Year 0 CF
Problem Intent: To illustrate construction of economic balance sheet from market data; to illustrate the use of economic balance sheet for valuation.
4. Whitemarble, a private equity firm, is considering the acquisition of Craft, Inc., a publicly held all-equity firm. Craft currently derives all its sales from the US market. Whitemarble expects to create value by expanding Craft’s sales to China and improving the efficiency of its US operations. Specifically, Whitemarble expects the following opportunities for value creation:
China segment This segment will create revenue of $800 one year after the acquisition, and this revenue is expected to increase at an annual rate of 4% in perpetuity. The pre-tax operating margin (i.e., EBITDA margin) on this increased revenue will be 20%. Pre-tax operating margin = (Revenue − Cash costs)/Revenue. Whitemarble estimates that the present value in Year 0 of future capital expenditures will be $1,800. There will be no need for additional working capital. The tax rate for this segment is zero.
U.S. segment Improving efficiency will reduce annual cash costs by $400, starting one year after the acquisition, and the decrease will be perpetual. That is, the difference between post- and pre-acquisition cash costs of US operations each year will be $400, and this difference will
exist in perpetuity. There will be no changes in capital expenditure or working capital. The tax rate for this segment is 25%. The WACC for both segments is 8%. Craft’s pre-acquisition stock price (before any news of acquisition became public) is $75 and it has 200 shares outstanding. What is Whitemarble’s breakeven price per share for Craft? Note that at the breakeven price the NPV of the acquisition to Whitemarble is zero
Problem Intent: To evaluate the value proposition in an acquisition.
5.Your company is planning the acquisition of Aldebaran Co. and wishes to estimate potential offering prices based on various multiples. The multiples you wish to use are P/E, Price to Book, Price to Revenue, and Enterprise Value to EBITDA. You have identified the recent acquisition of Orion Co. by another acquirer as a comparable acquisition and plan to use the transaction multiples from the Orion acquisition to estimate potential offer prices for Aldebaran (in practice you will use several comparable acquisitions, but for the purposes of this assignment one will suffice). The financial statements of Aldebaran and Orion and other relevant information are provided in a separate spreadsheet. For Aldebaran, assume: 1) No surplus cash; 2) Market value of long-term financial investments equals book value.
Calculate potential offer prices using each of the four multiples.
Problem Intent: To illustrate the use of multiples for valuation.