1. Estimating the Value of ACME
DES Chapter 4

2. Steps in a valuation Estimate cost of capital (WACC)
Debt
Equity
Project financial statements and FCF
Calculate horizon value
Discount at WACC to Calculate VOPS
Calculate value of equity
DES Chapter 4

3. Estimating the required return on the components of WACC
ACME has debt and equity
The cost of capital for each type of financing depends on it risk, as perceived by the investor, and taxes.
Higher risk securities have higher required rates of return.
If payments (like interest) are deductible, then the cost to the firm is lowered.
DES Chapter 4

4. Acme's WACC
Debt: Acme has 2 types of debt—short-term and long-term. The short-term rate is 9%.
Long-term debt: 8% coupon debt with 26 years left to maturity are selling for $ each. What is the cost (to ACME) of this source of capital?
DES Chapter 4

5. Bond prices
In general the price of a bond depends on its coupon payments, its maturity, and its risk.
ACME’s bonds pay $40 every 6 months, and $1,000 when they mature in 26 years.
DES Chapter 4

6. Bond prices M is the maturity value, or $1,000 for ACME
rC is the coupon rate, or 0.08, which is 8% for ACME
n is the maturity, or 26 x 2 = 52 6-month periods.
rD is the discount rate.
DES Chapter 4

7. ACME’s bond price
A financial calculator or a spreadsheet can be used to solve for rD, which is 4.5% for a 6-month period, or 9% per year.
DES Chapter 4

8. Cost of long-term debt
The cost of debt when it was issued 4 years ago was 8%, but the cost now is different because the bond price has declined from $1,000 to $900.15
Now the cost is 9%
DES Chapter 4

9. Cost of equity
The cost of equity (its required return) depends on how risky the stock is to investors.
This risk is measured by “Beta” and the Capital Asset Pricing Model (CAPM) relates Beta to the required return.
DES Chapter 4

10. ACME’s cost of equity CAPM: rS = rRF + Beta (RPM) Beta = 1.1
rRF = 5.4% = long term rate on Treasuries
RPM = market risk premium = 6%
rS = 5.4% + 1.1(6%) = 12%
DES Chapter 4

11. Target weights and WACC
Target is 30% debt, 70% equity
Tax rate = 40%
WACC = 0.70(12%) (9%)(1-0.40)
= 10.0%
This is the discount rate to be used for the free cash flows.
DES Chapter 4

12. Projections
Next chapter will have the nuts and bolts of projections. For now, assume that your financial analyst has already made the projections on the following page.
DES Chapter 4

13. Income statement projections
Income Statements
Actual
Projected
2009
2010
2011
2012
2013
Sales
4,512.44
4,873.44
5,165.84
5,475.80
5,804.34
Costs of Goods Sold
2,797.71
3,021.53
3,202.82
3,394.99
3,598.69 S
ales, General and Administrative
902.49
974.69
1,033.17
1,095.16
1,160.87
Depreciation
225.62
243.67
258.29
273.80
290.22
Operating Profit
586.62
633.55
671.56
711.85
754.56
Interest on original debt
80.00
Interest Expense on ne
w debt
25.73
34.35
42.84
50.18
57.95
Interest expense
105.73
114.35
122.84
130.18
137.95
Earnings Before Taxes
480.89
519.19
548.72
581.67
616.61
Taxes
192.35
207.68
219.49
232.67
246.65
Net Income
288.53
311.52
329.23
349.00
369.97
Dividends
104.89
135.10
191.43
202.90
215.05
Additions to retained earnings
183.64
176.41
137.80
146.11
154.91
DES Chapter 4

14. Balance Sheet Projections
Balance Sheets
Actual
Projected
Projected
Projected
Projected
2009
2010
2011
2012
2013
Cash
45.12
48.73
51.66
54.76
58.04
Inventory
631.74 6
82.28
723.22
766.61
812.61
Accounts receivable
1,128.11
1,218.36
1,291.46
1,368.95
1,451.09
Total current assets
1,804.98
1,949.38
2,066.34
2,190.32
2,321.74
Gross PPE
3,443.32
3,867.49
4,271.98
4,700.75
5,155.24
Accumulated depreciation
1,187.09
1,430
.77
1,689.06
1,962.85
2,253.07
Net PPE
2,256.22
2,436.72
2,582.92
2,737.90
2,902.17
Total assets
4,061.20
4,386.09
4,649.26
4,928.22
5,223.91
DES Chapter 4

15. Balance Sheet Projections
Liabilities
Actual
Projected
Projected
Projected
Projected
2009
2010
2011
2012
2013
Accounts payable
451.24
487.34
516.58
547.58
580.43
Accrued expenses
225.62
243.67
258.29
273.79
290.22
Short -
term debt
381.71
476.04
557.55
643.90
735.40
Total current liabilities
1,058.57
1,207.05
1,332.42
1,465.27
1,606.05
Long -
term debt
1,000.00
1,000.00
1,000.00
1,000.00
1,000.00
Total liabilities
2,058.57
2,207.05
2,332.42
2,465.27
2,606.05
Commo
n stock
600.00
600.00
600.00
600.00
600.00
Retained earnings
1,402.63
1,579.04
1,716.84
1,862.95
2,017.86
Total common equity
2,002.63
2,179.04
2,316.84
2,462.95
2,617.86
Total liabilities and equity
4,061.20
4,386.09
4,649.26
4,928.22
5,223.91
DES Chapter 4

16. FCF Projections Actual Projected 2009 2010 2011 2012 2013
Operating profit
586.62
633.55
671.56
711.85
754.56
Tax on operati
ng profit
234.65
253.42
268.62
284.74
301.83
NOPAT a
351.97
380.13
402.94
427.11
452.74
Operating current assets
1,804.97
1,949.37
2,066.34
2,190.32
2,321.74
Operating current liabilities
676.86
731.01
774.87
821.37
870.65
NOWC b
1,128.11
1,218.36
1,291. 47
1,368.95
1,451.09
Total operating capital c
3,384.34
3,655.08
3,874.39
4,106.85
4,353.26
Investment in total net
operating capital d
279.45
270.74
219.31
232.46
246.41
FCF e
72.52
109.39
183.63
194.65
206.33
DES Chapter 4

17. ROIC Projections Long term projected growth is 6% Actual Projected
2009
2010
2011
2012
2013
ROIC =
(NOPAT/Beginning capital)
11.3%
11.2%
11.0%
11.0%
11.0%
Growth in Sales
9.0%
8.0%
6.0%
6.0%
6.0%
Growth in NOPAT
9.0%
8.0%
6.0%
6.0%
6.0%
Growth in total net op. cap.
9.0%
8.0%
6.0%
6.0%
6.0%
Growth in FCF
376.6%
50.8%
67.9%
6.0%
6.0%
Growth in dividends
-34.5%
28.8%
41.7%
6.0%
6.0%
Long term projected growth is 6%
DES Chapter 4

18. Horizon Value
DES Chapter 4

19. Value of operations
DES Chapter 4

20. Value of equity Vequity = VOPS + non-operating assets – debt
Debt: $ million short term + 1 million long-term bonds at $ each
= = $1, million
Vequity = $4, ,281.86
= $2, million
DES Chapter 4

21. Per share equity 10 million shares outstanding
Value per share = $29.91
DES Chapter 4