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Chapter 13. Solution for Ch 13-11 Build a Model
The Henley Corporation is a privately held company specializing in lawn care products and services. The most recent
financial statements are shown below.
Income Statement for the Year Ending December 31 (Millions of Dollars)
2010
Net Sales $ 800.0
Costs (except depreciation) $ 576.0
Depreciation $ 60.0
Total operating costs $ 636.0
Earning before int. & tax $ 164.0
Less interest $ 32.0
Earning before taxes $ 132.0
Taxes (40%) $ 52.8
Net income before pref. div. $ 79.2
Preferred div. $ 1.4
Net income avail. for com. div. $ 77.9
Common dividends $ 31.1
Addition to retained earnings $ 46.7
Number of shares (in millions) 10
Dividends per share $ 3.11
Balance Sheets for December 31 (Millions of Dollars)
Assets 2010 Liabilities and Equity
Cash $ 8.0 Accounts Payable
Marketable Securities 20.0 Notes payable
Accounts receivable 80.0 Accruals
Inventories 160.0 Total current liabilities
Total current assets $ 268.0 Long-term bonds
Net plant and equipment 600.0 Preferred stock
Common Stock
Total Assets $ 868.0 (Par plus PIC)
Retained earnings
Common equity
Total liabilities and equity
Projected ratios and selected information for the current and projected years are shown below.
Inputs Actual Projected Projected Projected
2010 2011 2012 2013
Sales Growth Rate 15% 10% 6%
Costs / Sales 72% 72% 72% 72%
Depreciation / Net PPE 10% 10% 10% 10%
Cash / Sales 1% 1% 1% 1%
Acct. Rec. / Sales 10% 10% 10% 10%
Inventories / Sales 20% 20% 20% 20%
Net PPE / Sales 75% 75% 75% 75%
Acct. Pay. / Sales 2% 2% 2% 2%
Accruals / Sales 5% 5% 5% 5%
Tax rate 40% 40% 40% 40%
Weighted average cost of capital (WACC) 10.5% 10.5% 10.5% 10.5%
a. Forecast the parts of the income statement and balance sheets necessary to calculate free cash flow.
Partial Income Statement for the Year Ending December 31 (Millions of Dollars)
Actual Projected Projected Projected
2010 2011 2012 2013
Net Sales $ 800.0 $ 920.0 $ 1,012.0 $ 1,072.7
Costs (except depreciation) $ 576.0 $ 662.4 $ 728.6 $ 772.4
Depreciation $ 60.0 $ 69.0 $ 75.9 $ 80.5
Total operating costs $ 636.0 $ 731.4 $ 804.5 $ 852.8
Earning before int. & tax $ 164.0 $ 188.6 $ 207.5 $ 219.9
Partial Balance Sheets for December 31 (Millions of Dollars)
Actual Projected Projected Projected
Operating Assets 2010 2011 2012 2013
Cash $ 8.0 $ 9.2 $ 10.1 $ 10.7
Accounts receivable $ 80.0 $ 92.0 $ 101.2 $ 107.3
Inventories $ 160.0 $ 184.0 $ 202.4 $ 214.5
Net plant and equipment $ 600.0 $ 690.0 $ 759.0 $ 804.5
Operating Liabilities
Accounts Payable $ 16.0 $ 18.4 $ 20.2 $ 21.5
Accruals $ 40.0 $ 46.0 $ 50.6 $ 53.6
b. Calculate free cash flow for each projected year. Also calculate the growth rates of free cash flow each year to ensure
that there is constant growth (i.e., the same as the constant growth rate in sales) by the end of the forecast period.
Actual Projected Projected Projected
Calculation of FCF 2010 2011 2012 2013
Operating current assets 248.0 285.2 313.7 332.5
Operating current liabilities 56.0 64.4 70.8 75.1
Net operating working capital 192.0 220.8 242.9 257.5
Net PPE 600.0 690.0 759.0 804.5
Net operating capital 792.0 910.8 1,001.9 1,062.0
NOPAT 98.4 113.2 124.5 131.9
Investment in operating capital na 118.8 91.1 60.1
Free cash flow na (5.6) 33.4 71.8
Growth in FCF na na -692.1% 115.1%
Growth in sales 15.0% 10.0% 6.0%
c. Calculate operating profitability (OP=NOPAT/Sales), capital requirements (CR=Operating capital/Sales), and return
on invested capital (ROIC=NOPAT/Operating capital at beginning of year). Based on the spread between ROIC and
WACC, do you think that the company will have a positive market value added (MVA= Market value of company - book
value of company = Value of operations - Operating capital)?
c. Calculate operating profitability (OP=NOPAT/Sales), capital requirements (CR=Operating capital/Sales), and return
on invested capital (ROIC=NOPAT/Operating capital at beginning of year). Based on the spread between ROIC and
WACC, do you think that the company will have a positive market value added (MVA= Market value of company - book
value of company = Value of operations - Operating capital)?
Actual Projected Projected Projected
2010 2011 2012 2013
Operating profitability
(OP=NOPAT/Sales) 12.3% 12.3% 12.3% 12.3%
Capital requirement
(CR=Operating capital/Sales) 99.0% 99.0% 99.0% 99.0%
Return on invested capital
(ROIC=NOPAT/Operating capital at
start of year) na 14.3% 13.7% 13.2%
Weighted average cost of capital (WACC) na 10.5% 10.5% 10.5%
Spread between ROIC and WACC na 3.8% 3.2% 2.7%
Yes, because the spread is positive, the company should have a positive MVA.
d. Calculate the value of operations and MVA. (Hint: first calculate the horizon value at the end of the forecast period,
which is equal to the value of operations at the end of the forecast period. Assume that the annual growth rate beyond the
horizon is 6 percent.)
Actual Projected Projected Projected
2010 2011 2012 2013
Free cash flow (5.6) 33.4 71.8
Long-term constant growth in FCF
Weighted average cost of capital (WACC) 10.5% 10.5% 10.5% 10.5%
Horizon value
FCF in Years 1-3 and FCF4 + horizon value in Year 4 (5.6) 33.4 71.8
Value of operations (PV of FCF + HV) 1,329.6
Operating capital 792.0
Market value added (MVA=Market value of
company - book value of company = Value of
operations - Operating capital) 537.6
e. Calculate the price per share of common equity as of 12/31/2010.
Actual
2010
Value of Operations 1,329.6
Plus Value of Mkt. Sec. 20.0
Total Value of Company 1,349.6
Less Value of Debt 340.0
Less Value of Pref. 15.0
Value of Common Equity 994.6
Divided by number of shares 10
Price per share 99.5
4/11/2010
ces. The most recent
2010
$ 16.0
40.0
40.0
$ 96.0
$ 300.0
$ 15.0
$ 257.0
200.0
$ 457.0
$ 868.0
Projected
2014
6%
72%
10%
1%
10%
20%
75%
2%
5%
40%
10.5%
flow.
Projected
2014
$ 1,137.1
$ 818.7
$ 85.3
$ 904.0
$ 233.1
Projected
2014
$ 11.4
$ 113.7
$ 227.4
$ 852.8
$ 22.7
$ 56.9
flow each year to ensure
forecast period.
Projected
2014
352.5
79.6
272.9
852.8
1,125.7
139.9
63.7
76.1
6.0%
6.0%
pital/Sales), and return
between ROIC and
value of company - book
pital/Sales), and return
between ROIC and
value of company - book
Projected
2014
12.3%
99.0%
13.2%
10.5%
2.7%
of the forecast period,
l growth rate beyond the
Projected
2014
76.1
6.0%
10.5%
1,793.6
1,869.7
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