Chapter 11.

Solution for Ch 11-11 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)

2012
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 2012 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

2012 2013 2014 2015
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
2012 2013 2014 2015
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 2012 2013 2014 2015
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 2012 2013 2014 2015
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)?

Actual Projected Projected Projected

2012 2013 2014 2015
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

2012 2013 2014 2015
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 12/31/2012.

Actual
2012
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
 2/1/2012

and services. The most

2012
$ 16.0
40.0
40.0
$ 96.0
$ 300.0
$ 15.0

$ 257.0
200.0
$ 457.0
$ 868.0

below.

Projected
2016
6%
72%
 10%
1%
10%
20%
75%
2%
5%
40%
10.5%

e free cash flow.

Projected
2016
$ 1,137.1
$ 818.7
$ 85.3
$ 904.0
$ 233.1

Projected
2016
$ 11.4
$ 113.7
$ 227.4
$ 852.8

$ 22.7
$ 56.9

ree cash flow each year

es) by the end of the

Projected
2016
352.5
79.6
272.9
852.8
1,125.7
139.9
63.7
76.1
6.0%
6.0%
ing capital/Sales), and
on the spread between
(MVA= Market value of

Projected
2016

12.3%

99.0%

13.2%
10.5%
2.7%

the end of the forecast

me that the annual

Projected
2016
76.1
6.0%
10.5%
1,793.6
1,869.7