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The purpose of this assignment is to explain core concepts related to stocks and to analyze the ethical implications of decisions and promote ethical standards within organizations.
Read the Chapter 7 Mini Case on pages 339-341 in Financial Management: Theory and Practice. Using complete sentences and academic vocabulary, please answer questions a through d.
Using the mini case information, write a 250-500 word report presenting potential ethical issues that may arise from expanding into other related fields. In your discussion, proactively strategize about possible expansion by explaining opportunities to promote ethical standards within your organization.
While APA style is not required for the body of this assignment, solid academic writing is expected, and documentation of sources should be presented using APA formatting guidelines, which can be found in the APA Style Guide, located in the Student Success Center.
This assignment uses a rubric. Please review the rubric prior to beginning the assignment to become familiar with the expectations for successful completion.
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10/11/18, 5(50 PM
Chapter 7: Corporate Valuation and Stock Valuation Mini Case
Book Title: Financial Management: Theory and Practice
Printed By: Brad VandeLune (bvandelune@my.gcu.edu)
© 2017 Cengage Learning, Cengage Learning
Chapter Review
Mini Case
Your employer, a mid-sized human resources management company, is considering
expansion into related fields, including the acquisition of Temp Force Company, an
employment agency that supplies word processor operators and computer programmers to
businesses with temporary heavy workloads. Your employer is also considering the
purchase of Biggerstaff & McDonald (B&M), a privately held company owned by two friends,
each with 5 million shares of stock. B&M currently has free cash flow of $24 million, which is
expected to grow at a constant rate of 5%. B&M’s financial statements report short-term
investments of $100 million, debt of $200 million, and preferred stock of $50 million. B&M’s
weighted average cost of capital (WACC) is 11%. Answer the following questions.
a. Describe briefly the legal rights and privileges of common stockholders.
b. What is free cash flow (FCF)? What is the weighted average cost of capital? What is
the free cash flow valuation model?
c. Use a pie chart to illustrate the sources that comprise a hypothetical company’s total
value. Using another pie chart, show the claims on a company’s value. How is equity
a residual claim?
d. Suppose the free cash flow at Time 1 is expected to grow at a constant rate of
forever. If
, what is a formula for the present value of expected free cash
flows when discounted at the WACC? If the most recent free cash flow is expected to
grow at a constant rate of
forever (and
), what is a formula for the
present value of expected free cash flows when discounted at the WACC?
e. Use B&M’s data and the free cash flow valuation model to answer the following
questions.
1. What is its estimated value of operations?
2. What is its estimated total corporate value? (This is the entity value.)
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3. What is its estimated intrinsic value of equity?
4. What is its estimated intrinsic stock price per share?
f. You have just learned that B&M has undertaken a major expansion that will change its
expected free cash flows to −$10 million in 1 year, $20 million in 2 years, and $35
million in 3 years. After 3 years, free cash flow will grow at a rate of 5%. No new debt
or preferred stock was added; the investment was financed by equity from the owners.
Assume the WACC is unchanged at 11% and that there are still 10 million shares of
stock outstanding.
1. What is the company’s horizon value (i.e., its value of operations at Year 3)?
What is its current value of operations (i.e., at Time 0)?
2. What is its estimated intrinsic value of equity on a price-per-share basis?
g. If B&M undertakes the expansion, what percent of B&M’s value of operations at Year
0 is due to cash flows from Years 4 and beyond? (Hint: Use the horizon value at
to help answer this question.)
h. Based on your answer to the previous question, what are two reasons why managers
often emphasize short-term earnings?
i. Your employer also is considering the acquisition of Hatfield Medical Supplies. You
have gathered the following data regarding Hatfield, with all dollars reported in
millions: (1) most recent sales of $2,000; (2) most recent total net operating capital,
; (3) most recent operating profitability ratio,
; and (4) most recent capital requirement ratio,
. You estimate that the growth rate in sales from Year 0 to
Year 1 will be 10%, from Year 1 to Year 2 will be 8%, from Year 2 to Year 3 will be 5%,
and from Year 3 to Year 4 will be 5%. You also estimate that the long-term growth rate
beyond Year 4 will be 5%. Assume the operating profitability and capital requirement
ratios will not change. Use this information to forecast Hatfield’s sales, net operating
profit after taxes (NOPAT), OpCap, free cash flow, and return on invested capital
(ROIC) for Years 1 through 4. Also estimate the annual growth in free cash flow for
Years 2 through 4. The weighted average cost of capital (WACC) is 9%. How does the
ROIC in Year 4 compare with the WACC?
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j. What is the horizon value at Year 4? What is the total net operating capital at Year 0?
How does the value of operations compare with the current total net operating
capital?
k. What are value drivers? What happens to the ROIC and current value of operations if
expected growth increases by 1 percentage point relative to the original growth rates
(including the long-term growth rate)? What can explain this? (Hint: Use Scenario
Manager.)
l. Assume growth rates are at their original levels. What happens to the ROIC and
current value of operations if the operating profitability ratio increases to 5.5%? Now
assume growth rates and operating profitability ratios are at their original levels. What
happens to the ROIC and current value of operations if the capital requirement ratio
decreases to 51%? Assume growth rates are at their original levels. What is the
impact of simultaneous improvements in operating profitability and capital
requirements? What is the impact of simultaneous improvements in the growth rates,
operating profitability, and capital requirements? (Hint: Use Scenario Manager.)
m. What insight does the free cash flow valuation model provide regarding possible
reasons for market volatility? (Hint: Look at the value of operations for the
combinations of ROIC and
n.
in the previous questions.)
1. Write out a formula that can be used to value any dividend-paying stock,
regardless of its dividend pattern.
2. What is a constant growth stock? How are constant growth stocks valued?
3. What happens if a company has a constant
that exceeds its
? Will many
stocks have expected growth greater than the required rate of return in the short
run (i.e., for the next few years)? In the long run (i.e., forever)?
o. Assume that Temp Force has a beta coefficient of 1.2, that the risk-free rate (the yield
on T-bonds) is 7.0%, and that the market risk premium is 5%. What is the required
rate of return on the firm’s stock?
p. Assume that Temp Force is a constant growth company whose last dividend (
,
which was paid yesterday) was $2.00 and whose dividend is expected to grow
indefinitely at a 6% rate.
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1. What is the firm’s current estimated intrinsic stock price?
2. What is the stock’s expected value 1 year from now?
3. What are the expected dividend yield, the expected capital gains yield, and the
expected total return during the first year?
q. Now assume that the stock is currently selling at $30.29. What is its expected rate of
return?
r. Now assume that Temp Force’s dividend is expected to experience nonconstant
growth of 30% from Year 0 to Year 1, 25% from Year 1 to Year 2, and 15% from Year
2 to Year 3. After Year 3, dividends will grow at a constant rate of 6%. What is the
stock’s intrinsic value under these conditions? What are the expected dividend yield
and capital gains yield during the first year? What are the expected dividend yield and
capital gains yield during the fourth year (from Year 3 to Year 4)?
s. What is the market multiple method of valuation? What are its strengths and
weaknesses?
t. What are the advantages of the free cash flow valuation model relative to the dividend
growth model?
u. What is preferred stock? Suppose a share of preferred stock pays a dividend of $2.10
and investors require a return of 7%. What is the estimated value of the preferred
stock?
Chapter 7: Corporate Valuation and Stock Valuation Mini Case
Book Title: Financial Management: Theory and Practice
Printed By: Brad VandeLune (bvandelune@my.gcu.edu)
© 2017 Cengage Learning, Cengage Learning
© 2018 Cengage Learning Inc. All rights reserved. No part of this work may by reproduced or used in any form or by any means graphic, electronic, or mechanical, or in any other manner – without the written permission of the copyright holder.
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10/11/18, 5(50 PM
Chapter 7: Corporate Valuation and Stock Valuation Mini Case
Book Title: Financial Management: Theory and Practice
Printed By: Brad VandeLune (bvandelune@my.gcu.edu)
© 2017 Cengage Learning, Cengage Learning
Chapter Review
Mini Case
Your employer, a mid-sized human resources management company, is considering
expansion into related fields, including the acquisition of Temp Force Company, an
employment agency that supplies word processor operators and computer programmers to
businesses with temporary heavy workloads. Your employer is also considering the
purchase of Biggerstaff & McDonald (B&M), a privately held company owned by two friends,
each with 5 million shares of stock. B&M currently has free cash flow of $24 million, which is
expected to grow at a constant rate of 5%. B&M’s financial statements report short-term
investments of $100 million, debt of $200 million, and preferred stock of $50 million. B&M’s
weighted average cost of capital (WACC) is 11%. Answer the following questions.
a. Describe briefly the legal rights and privileges of common stockholders.
b. What is free cash flow (FCF)? What is the weighted average cost of capital? What is
the free cash flow valuation model?
c. Use a pie chart to illustrate the sources that comprise a hypothetical company’s total
value. Using another pie chart, show the claims on a company’s value. How is equity
a residual claim?
d. Suppose the free cash flow at Time 1 is expected to grow at a constant rate of
forever. If
, what is a formula for the present value of expected free cash
flows when discounted at the WACC? If the most recent free cash flow is expected to
grow at a constant rate of
forever (and
), what is a formula for the
present value of expected free cash flows when discounted at the WACC?
e. Use B&M’s data and the free cash flow valuation model to answer the following
questions.
1. What is its estimated value of operations?
2. What is its estimated total corporate value? (This is the entity value.)
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3. What is its estimated intrinsic value of equity?
4. What is its estimated intrinsic stock price per share?
f. You have just learned that B&M has undertaken a major expansion that will change its
expected free cash flows to −$10 million in 1 year, $20 million in 2 years, and $35
million in 3 years. After 3 years, free cash flow will grow at a rate of 5%. No new debt
or preferred stock was added; the investment was financed by equity from the owners.
Assume the WACC is unchanged at 11% and that there are still 10 million shares of
stock outstanding.
1. What is the company’s horizon value (i.e., its value of operations at Year 3)?
What is its current value of operations (i.e., at Time 0)?
2. What is its estimated intrinsic value of equity on a price-per-share basis?
g. If B&M undertakes the expansion, what percent of B&M’s value of operations at Year
0 is due to cash flows from Years 4 and beyond? (Hint: Use the horizon value at
to help answer this question.)
h. Based on your answer to the previous question, what are two reasons why managers
often emphasize short-term earnings?
i. Your employer also is considering the acquisition of Hatfield Medical Supplies. You
have gathered the following data regarding Hatfield, with all dollars reported in
millions: (1) most recent sales of $2,000; (2) most recent total net operating capital,
; (3) most recent operating profitability ratio,
; and (4) most recent capital requirement ratio,
. You estimate that the growth rate in sales from Year 0 to
Year 1 will be 10%, from Year 1 to Year 2 will be 8%, from Year 2 to Year 3 will be 5%,
and from Year 3 to Year 4 will be 5%. You also estimate that the long-term growth rate
beyond Year 4 will be 5%. Assume the operating profitability and capital requirement
ratios will not change. Use this information to forecast Hatfield’s sales, net operating
profit after taxes (NOPAT), OpCap, free cash flow, and return on invested capital
(ROIC) for Years 1 through 4. Also estimate the annual growth in free cash flow for
Years 2 through 4. The weighted average cost of capital (WACC) is 9%. How does the
ROIC in Year 4 compare with the WACC?
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j. What is the horizon value at Year 4? What is the total net operating capital at Year 0?
How does the value of operations compare with the current total net operating
capital?
k. What are value drivers? What happens to the ROIC and current value of operations if
expected growth increases by 1 percentage point relative to the original growth rates
(including the long-term growth rate)? What can explain this? (Hint: Use Scenario
Manager.)
l. Assume growth rates are at their original levels. What happens to the ROIC and
current value of operations if the operating profitability ratio increases to 5.5%? Now
assume growth rates and operating profitability ratios are at their original levels. What
happens to the ROIC and current value of operations if the capital requirement ratio
decreases to 51%? Assume growth rates are at their original levels. What is the
impact of simultaneous improvements in operating profitability and capital
requirements? What is the impact of simultaneous improvements in the growth rates,
operating profitability, and capital requirements? (Hint: Use Scenario Manager.)
m. What insight does the free cash flow valuation model provide regarding possible
reasons for market volatility? (Hint: Look at the value of operations for the
combinations of ROIC and
n.
in the previous questions.)
1. Write out a formula that can be used to value any dividend-paying stock,
regardless of its dividend pattern.
2. What is a constant growth stock? How are constant growth stocks valued?
3. What happens if a company has a constant
that exceeds its
? Will many
stocks have expected growth greater than the required rate of return in the short
run (i.e., for the next few years)? In the long run (i.e., forever)?
o. Assume that Temp Force has a beta coefficient of 1.2, that the risk-free rate (the yield
on T-bonds) is 7.0%, and that the market risk premium is 5%. What is the required
rate of return on the firm’s stock?
p. Assume that Temp Force is a constant growth company whose last dividend (
,
which was paid yesterday) was $2.00 and whose dividend is expected to grow
indefinitely at a 6% rate.
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1. What is the firm’s current estimated intrinsic stock price?
2. What is the stock’s expected value 1 year from now?
3. What are the expected dividend yield, the expected capital gains yield, and the
expected total return during the first year?
q. Now assume that the stock is currently selling at $30.29. What is its expected rate of
return?
r. Now assume that Temp Force’s dividend is expected to experience nonconstant
growth of 30% from Year 0 to Year 1, 25% from Year 1 to Year 2, and 15% from Year
2 to Year 3. After Year 3, dividends will grow at a constant rate of 6%. What is the
stock’s intrinsic value under these conditions? What are the expected dividend yield
and capital gains yield during the first year? What are the expected dividend yield and
capital gains yield during the fourth year (from Year 3 to Year 4)?
s. What is the market multiple method of valuation? What are its strengths and
weaknesses?
t. What are the advantages of the free cash flow valuation model relative to the dividend
growth model?
u. What is preferred stock? Suppose a share of preferred stock pays a dividend of $2.10
and investors require a return of 7%. What is the estimated value of the preferred
stock?
Chapter 7: Corporate Valuation and Stock Valuation Mini Case
Book Title: Financial Management: Theory and Practice
Printed By: Brad VandeLune (bvandelune@my.gcu.edu)
© 2017 Cengage Learning, Cengage Learning
© 2018 Cengage Learning Inc. All rights reserved. No part of this work may by reproduced or used in any form or by any means graphic, electronic, or mechanical, or in any other manner – without the written permission of the copyright holder.
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