Instructions for Problem Set #2

Instructions for Problem Set #2 -

SECTION 1- ANALYZING PERFORMANCE (using financial information provided)

1) Calculate the most recent two year CAGR (ie from 2012 to 2014) for all lines

Remember that CAGR is the compound annual growth rate (ie that the growth from 2012 to 2014 would be the ((2014 figure/2012 figure) ^0.5)-1

2) Calculate common sized income statement and common sized balance sheet where indicated

3) Calculate the following ratios for all 3 years: (be sure to use two point averages for the “Days” calculations where you can so you should do so for all years but the first year – 2012)

a. Cash ratio

b. Quick ratio

c. Current ratio

d. Debt to Equity

e. Days Receivables

f. Days Inventory

g. Days Payable

h. Net working capital

4) Calculate cash conversion cycle for 2012-2014

5) Using 2012 as baseline, how much additional cash is being used/has been freed up by 2014 (i.e. the difference in net working capital)

SECTION 2- RETURNS AND VOLATILITY (add rows to show work, label answers)

6) Deere & Co (also known as John Deere, symbol DE) is a heavy equipment manufacturer with global headquarters near Moline, IL. The company’s performance is very sensitive to changes in the economy. Given the following economic states and the resulting performance of Deere’s common stock and long-term debt, calculate the following:

a. Expected return of both stock and l-t bonds

b. If an investor (who really, really likes Deere) has 67% of her portfolio in DE stock and 33% in DE bonds, calculate the expected return of her portfolio

Economic State	Probability	Common Stock	Long-term Bond
Boom	20%	18%	5%
Good	35%	12%	6%
Fair	25%	8%	7%
Recession	20%	-8%	8%

7) Continuing with the same information for the investor in question #1, what is the variance of the portfolio?

8) Continuing with the same information for the investor in question #1, what is the standard deviation of the portfolio?

SECTION 3- VALUATION USING FINANCIAL DATA AT TOP OF TEMPLATE

(add rows to show work, label answers)

9) Similar to the first problem set, calculate the interest rate for 2014 on Deere long-term debt (remember, it’s both LT Debt and Current Portions of LT Debt). Assume that all interest expense is related to the debt and use a two-point average to get the average amount of LT debt for 2014.

10) Given a market return rate of 12% and a T-Bill rate of 3%, calculate the market risk premium

11) Using the Beta as given and using CAPM, what is DE’s cost of common equity

12) Similar to the first problem set, a) calculate DE’s annual dividends per share (DPS) for 2012, 2013, and 2014. Calculate b) the compound annual growth rate in DPS from 2012 - 2014 (remember to use the correct CAGR formula). Use this growth rate as “g” and the cost of equity calculated in #11 as “r”. Calculate c) the dividend per share in 2015 using the 2014 DPS and g, calculate d) the value of a share of DE stock based on the calculated dividend for 2015 as the next dividend, the calculated “g” as the growth rate, and the cost of equity calculated for “r”.

13) Based on the # of shares given, calculate a) DE’s market value of equity. Now assume LT debt to be valued at face-value for calculating the capital composition - what is b) total capital (LT debt + equity) and c) the % weight of DE’s LT debt and equity (should add up to 100% - don’t forget to include the current portion of the LT debt as well)

14) Calculate DE’s effective tax rate for 2014 by dividing tax expense by taxable income.

15) Given your previous answers – what is DE’s weighted average cost of capital?

SECTION 4 - INVESTMENT ANALYSIS (add rows to show work, label answers)

16) DE has an investment opportunity for purchasing energy saving production equipment. It will replace less efficient equipment, which has no salvage value. You will sell the new equipment at the end of the 5 year project time period. The annual energy savings are pre-tax. Here are the specifics (all numbers in 000s):

Cost of New Equipment $10,000

Annual energy savings $2,500

Life of equipment 5 years

Salvage value (at end of 5 yrs) 10%

Depreciation – straightline 5 years

Tax rate specific to this project 30%

Using the wacc in #15 as the discount rate, what is the present value of the depreciation tax shield in this problem?

17) Based on the wacc calculated in #11, what is the NPV? What is the IRR? Should DE take on this project?

18) The neighboring government of East Moline, IL has offered DE a compensation package to reduce the risk of the investment. The net effect is to reduce the risk of the project as measured by the project beta by 50%. Calculate the new wacc relevant to this project. Should DE now take on the project?

19) Based on market reaction to announcement of the project, assume DE’s stock price is now $82. An investor thinks the price of DE will go up so he is going to buy 10,000 total (ie 100 bundles of 100 options) call options that expire in 2018. The exercise price will be $90 and he will pay $6 for each call option. Including his purchase amount, a) what is his total $ return if DE stock goes to $75 and stays there indefinitely, b) total $ return if DE goes to $90 and stays there indefinitely, c) total $ return if DE goes to $110 and stays there indefinitely, and d) total $ return if DE goes to $130 and stays there indefinitely?

20) Rather than use existing funds, DE is looking at raising money through an offering of equity to a limited number of large private investors. They want to raise $20,000,000. They will offer exactly 200,000 shares and would like to get $100 per share. They will use a Dutch auction. Here are the bids by the investors:

Investor	Price Offered	Quantity
A	$105	30,000
B	$103	25,000
C	$101	35,000
D	$100	15,000
E	$97	40,000
F	$96	30,000
G	$95	50,000
H	$93	20,000

Based on the Dutch auction approach: 1) were they able to sell all 200,000 shares?, and 2) what was the common price they all bought at?

21) BONUS - based on #20, how many shares did each bidder get to purchase?