Chapter 13.

Ch 13-11 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)

2010
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 2010 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

2010 2011 2012 2013
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
2010 2011 2012 2013
Net Sales $ 800.0
Costs (except depreciation) $ 576.0
Depreciation $ 60.0
Total operating costs $ 636.0
Earning before int. & tax $ 164.0

Partial Balance Sheets for December 31 (Millions of Dollars)

Actual Projected Projected Projected
Operating Assets 2010 2011 2012 2013
Cash $ 8.0
Accounts receivable $ 80.0
Inventories $ 160.0
Net plant and equipment $ 600.0

Operating Liabilities
Accounts Payable $ 16.0
Accruals $ 40.0

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 2010 2011 2012 2013
Operating current assets
Operating current liabilities
Net operating working capital
Net PPE
Net operating capital
NOPAT
Investment in operating capital na
Free cash flow na
Growth in FCF na na
Growth in sales
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

2010 2011 2012 2013
Operating profitability
(OP=NOPAT/Sales)
Capital requirement
(CR=Operating capital/Sales)
Return on invested capital
(ROIC=NOPAT/Operating capital at
start of year) na
Weighted average cost of capital (WACC) na
Spread between ROIC and WACC na

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

2010 2011 2012 2013
Free cash flow
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
Value of operations (PV of FCF + HV)

Operating capital

Market value added (MVA=Market value of company

- book value of company = Value of operations -
Operating capital)

e. Calculate the price per share of common equity as of 12/31/2010.

Actual
2010
Value of Operations
Plus Value of Mkt. Sec.
Total Value of Company
Less Value of Debt
Less Value of Pref.
Value of Common Equity
Divided by number of shares
Price per share
 4/16/2010

es. The most recent

2010
$ 16.0
40.0
40.0
$ 96.0
$ 300.0
$ 15.0

$ 257.0
200.0
$ 457.0
$ 868.0

Projected
2014
6%
72%
 10%
1%
10%
20%
75%
2%
5%
40%
10.5%

ow.

Projected
2014

Projected
2014

ow each year to ensure

orecast period.
Projected
2014
pital/Sales), and return on
tween ROIC and WACC,
ompany - book value of

Projected
2014

of the forecast period,

growth rate beyond the

Projected
2014

10.5%