Financial Planning Problems

9-19. IDX Technologies is a privately held developer of advanced security systems based in Chicago.

As part of your business development strategy, in late 2008 you initiate discussions with IDX’s

founder about the possibility of acquiring the business at the end of 2008. Estimate the value of

IDX per share using a discounted FCF approach and the following data:

? Debt: $30 million

? Excess cash: $110 million

? Shares outstanding: 50 million

? Expected FCF in 2009: $45 million

? Expected FCF in 2010: $50 million

? Future FCF growth rate beyond 2010: 5%

? Weighted-average cost of capital: 9.4%

From 2010 on, we expect FCF to grow at a 5% rate. Thus, using the growing perpetuity formula, we

9-20. Sora Industries has 60 million outstanding shares, $120 million in debt, $40 million in cash, and

the following projected free cash flow for the next four years:

a. Suppose Sora’s revenue and free cash flow are expected to grow at a 5% rate beyond year 4.

If Sora’s weighted average cost of capital is 10%, what is the value of Sora’s stock based on

this information?

b. Sora’s cost of goods sold was assumed to be 67% of sales. If its cost of goods sold is actually

70% of sales, how would the estimate of the stock’s value change?

c. Let’s return to the assumptions of part (a) and suppose Sora can maintain its cost of goods

sold at 67% of sales. However, now suppose Sora reduces its selling, general, and

administrative expenses from 20% of sales to 16% of sales. What stock price would you

estimate now? (Assume no other expenses, except taxes, are affected.)

*d. Sora’s net working capital needs were estimated to be 18% of sales (which is their current

level in year 0). If Sora can reduce this requirement to 12% of sales starting in year 1, but all

other assumptions remain as in part (a), what stock price do you estimate for Sora? (Hint:

This change will have the largest impact on Sora’s free cash flow in year 1.)

9-21. Consider the valuation of Kenneth Cole Productions in Example 9.7.

a. Suppose you believe KCP’s initial revenue growth rate will be between 4% and 11% (with

growth slowing in equal steps to 4% by year 2011). What range of share prices for KCP is

consistent with these forecasts?

b. Suppose you believe KCP’s EBIT margin will be between 7% and 10% of sales. What range

of share prices for KCP is consistent with these forecasts (keeping KCP’s initial revenue

growth at 9%)?

c. Suppose you believe KCP’s weighted average cost of capital is between 10% and 12%. What

range of share prices for KCP is consistent with these forecasts (keeping KCP’s initial

revenue growth and EBIT margin at 9%)?

Berk/DeMarzo • Corporate Finance, Second Edition131

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d. What range of share prices is consistent if you vary the estimates as in parts (a), (b), and (c)

simultaneously?

9-22. You notice that PepsiCo has a stock price of $52.66 and EPS of $3.20. Its competitor, the Coca-

Cola Company, has EPS of $2.49. Estimate the value of a share of Coca-Cola stock using only

this data.

PepsiCo P/E = 52.66/3.20 = 16.46x. Apply to Coca-Cola: $2.49 ×16.46 = $40.98.

9-23. Suppose that in January 2006, Kenneth Cole Productions had EPS of $1.65 and a book value of

equity of $12.05 per share.

a. Using the average P/E multiple in Table 9.1, estimate KCP’s share price.

b. What range of share prices do you estimate based on the highest and lowest P/E multiples in

Table 9.1?

c. Using the average price to book value multiple in Table 9.1, estimate KCP’s share price.

d. What range of share prices do you estimate based on the highest and lowest price to book

value multiples in Table 9.1?

9-24. Suppose that in January 2006, Kenneth Cole Productions had sales of $518 million, EBITDA of

$55.6 million, excess cash of $100 million, $3 million of debt, and 21 million shares outstanding.

a. Using the average enterprise value to sales multiple in Table 9.1, estimate KCP’s share price.

b. What range of share prices do you estimate based on the highest and lowest enterprise value

to sales multiples in Table 9.1?

c. Using the average enterprise value to EBITDA multiple in Table 9.1, estimate KCP’s share

price.

d. What range of share prices do you estimate based on the highest and lowest enterprise value

to EBITDA multiples in Table 9.1?

9-25. In addition to footwear, Kenneth Cole Productions designs and sells handbags, apparel, and

other accessories. You decide, therefore, to consider comparables for KCP outside the footwear

industry.

a. Suppose that Fossil, Inc., has an enterprise value to EBITDA multiple of 9.73 and a P/E

multiple of 18.4. What share price would you estimate for KCP using each of these multiples,

based on the data for KCP in Problems 23 and 24?

b. Suppose that Tommy Hilfiger Corporation has an enterprise value to EBITDA multiple of

7.19 and a P/E multiple of 17.2. What share price would you estimate for KCP using each of

these multiples, based on the data for KCP in Problems 23 and 24?

9-26. Consider the following data for the airline industry in early 2009 (EV = enterprise value, BV =

book value, NM = not meaningful because divisor is negative). Discuss the challenges of using

multiples to value an airline.

All the multiples show a great deal of variation across firms. This makes the use of multiples

problematic because there is clearly more to valuation than the multiples reveal. Without a clear

understanding of what drives the differences in multiples across airlines, it is unclear what the

“correct” multiple to use is when trying to value a new airline.

9-27. You read in the paper that Summit Systems from Problem 6 has revised its growth prospects

and now expects its dividends to grow at 3% per year forever.

a. What is the new value of a share of Summit Systems stock based on this information?

b. If you tried to sell your Summit Systems stock after reading this news, what price would you

be likely to get and why?

9-28. In early 2009, Coca-Cola Company had a share price of $46. Its dividend was $1.52, and you

expect Coca-Cola to raise this dividend by approximately 7% per year in perpetuity.

a. If Coca-Cola’s equity cost of capital is 8%, what share price would you expect based on your

estimate of the dividend growth rate?

b. Given Coca-Cola’s share price, what would you conclude about your assessment of Coca-

Cola’s future dividend growth?

.

9-29. Roybus, Inc., a manufacturer of flash memory, just reported that its main production facility in

Taiwan was destroyed in a fire. While the plant was fully insured, the loss of production will

decrease Roybus’ free cash flow by $180 million at the end of this year and by $60 million at the

end of next year.

a. If Roybus has 35 million shares outstanding and a weighted average cost of capital of 13%,

what change in Roybus’ stock price would you expect upon this announcement? (Assume the

value of Roybus’ debt is not affected by the event.)

b. Would you expect to be able to sell Roybus’ stock on hearing this announcement and make a

profit? Explain.

9-30. Apnex, Inc., is a biotechnology firm that is about to announce the results of its clinical trials of a

potential new cancer drug. If the trials were successful, Apnex stock will be worth $70 per share.

If the trials were unsuccessful, Apnex stock will be worth $18 per share. Suppose that the

morning before the announcement is scheduled, Apnex shares are trading for $55 per share.

a. Based on the current share price, what sort of expectations do investors seem to have about

the success of the trials?

b. Suppose hedge fund manager Paul Kliner has hired several prominent research scientists to

examine the public data on the drug and make their own assessment of the drug’s promise.

Would Kliner’s fund be likely to profit by trading the stock in the hours prior to the

announcement?

c. What would limit the fund’s ability to profit on its information?

.