Financial Questions
Problem 918
"Heavy Metal Corporation is expected to generate the following free cash flows over the next
five years:"
Year 1 2 3 4 5
FCF ($ million) 53 68 78 75 82
After then, the free cash flows are expected to grow at the industry average of 4% per year. Using the discounted free cash flow model and a weighted average cost of capital of 14%:
a. Estimate the enterprise value of Heavy Metal.
b. If Heavy Metal has no excess cash, debt of $300 million, and 40 million shares outstanding, estimate its share price.
Problem 920 


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: 

Year 
0 
1 
2 
3 
4 

Earnings and FCF Forecast ($ million) 







1 
Sales 

433.0 
468.0 
516.0 
547.0 
574.3 

2 
Growth versus Prior Year 


8.1% 
10.3% 
6.0% 
5.0% 

3 
Cost of Goods Sold 


(313.6) 
(345.7) 
(366.5) 
(384.8) 

4 
Gross Profit 


154.4 
170.3 
180.5 
189.5 

5 
Selling, General, and Administrative 


(93.6) 
(103.2) 
(109.4) 
(114.9) 

6 
Depreciation 


(7.0) 
(7.5) 
(9.0) 
(9.5) 

7 
EBIT 


53.8 
59.6 
62.1 
65.2 

8 
Less: Income Tax at 40% 


(21.5) 
(23.8) 
(24.8) 
(26.1) 

9 
Plus: Depreciation 


7.0 
7.5 
9.0 
9.5 

10 
Less: Capital Expenditures 


(7.7) 
(10.0) 
(9.9) 
(10.4) 

11 
Less: Increase in NWC 


(6.3) 
(8.6) 
(5.6) 
(4.9) 

12 
Free Cash Flow 


25.3 
24.6 
30.8 
33.3 

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.) 

Problem 921 


Consider the valuation of Kenneth Cole Productions in Example 9.7. 

a. 
Suppose you believe KCP’s initial revenue growth rate will be between 7% 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%)? 

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

Problem 923 


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? 
Problem 924
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?
Problem 925
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.
Kenneth Cole information
EPS 1.65
EBITDA55.60
Cash 100.00
Debt 3.00
Shares outstanding 21
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?
Problem 926
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 usefulness of using multiples to value an airline.
Company Name Market Cap EV EV/Sales EV/EBITDA EV/EBIT P/E P/Book
Delta Air Lines 4,799.60 16,887.60 0.7 15.0 NM NM NM
AMR Corp. 1,296.50 8,743.50 0.4 17.5 NM NM NM
JetBlue Airways 1,246.90 3,834.90 1.1 10.4 25.7 NM 1.0x
Continental Airlines 1,216.80 4,506.80 0.3 14.7 NM NM NM
UAL Corp. 701 6,192.00 0.3 NM NM NM NM
Air Tran Holdings 651.3 1,354.70 0.5 21.7 NM NM 2.3
SkyWest 588.7 1,699.70 0.5 3.8 7.5 6.5 0.5
Hawaiian 257.1 262.1 0.2 1.7 2.7 3.6 NM
Pinnacle Airlines 44 699.7 0.8 6.6 10.1 3.4 1.0

Rating:
5/
Solution: Financial Questions