Question: A client explains that her firm's value must be affected by the choice of explicit forecast horizon. To build a model to test her claim,
| A client explains that her firm's value must be affected by the choice of explicit forecast horizon. To build a model to test her claim, you are provided the information of her company as below: | ||||||
| Note: all units in millions | ||||||
| Income Statements | Actual | Projected | Projected | Projected | Projected | |
| 2021 | 2022 | 2023 | 2024 | 2025 | ||
| Sales | 4,512.44 | Sales growth rate | 8.0% | 6.0% | 6.0% | 6.0% |
| Costs of Goods Sold | 2,797.71 | COGS / Sales | 62.0% | 62.0% | 62.0% | 62.0% |
| Sales, General and Administrative | 902.49 | SGA / Sales | 20.0% | 20.0% | 20.0% | 20.0% |
| Depreciation | 225.62 | Depreciation / Net PPE | 10.0% | 10.0% | 10.0% | 10.0% |
| Operating Profit | 586.62 | |||||
| Interest Income | 0.00 | Interest Rate on Short-term Investment | 3.0% | 3.0% | 3.0% | 3.0% |
| Interest expense | 105.73 | Interest Rate on Debt | 8.0% | 8.0% | 8.0% | 8.0% |
| Earnings Before Taxes | 480.89 | |||||
| Taxes | 192.36 | Tax Rate (Taxes/EBT) | 40.0% | 40.0% | 40.0% | 40.0% |
| Net Income | 288.53 | |||||
| Dividends | 104.89 | Dividend growth rate | 28.8% | 41.7% | 6.0% | 6.0% |
| Additions to retained earnings | 183.64 | |||||
| Balance Sheets | Actual | |||||
| 2021 | ||||||
| Cash | 45.12 | Cash / Sales | 1.0% | 1.0% | 1.0% | 1.0% |
| Inventory | 631.74 | Inventory/ Sales | 14.0% | 14.0% | 14.0% | 14.0% |
| Accounts receivable | 1,128.11 | Accts. Rec. / Sales | 25.0% | 25.0% | 25.0% | 25.0% |
| Total current assets | 1,804.97 | |||||
| Net PPE | 2,256.23 | Net PPE / Sales | 50.0% | 50.0% | 50.0% | 50.0% |
| Total assets | 4,061.20 | |||||
| Accounts payable | 451.24 | Accts. Pay./ Sales | 10.0% | 10.0% | 10.0% | 10.0% |
| Accrued expenses | 225.62 | Accruals / Sales | 5.0% | 5.0% | 5.0% | 5.0% |
| Short-term debt | 381.71 | |||||
| Total current liabilities | 1,058.57 | |||||
| Long-term debt | 1,000.00 | Long-term Debt / operating assets | 22.8% | 22.0% | 22.0% | 22.0% |
| Total liabilities | 2,058.57 | |||||
| Common stock (100 million shares) | 600.00 | |||||
| Retained earnings | 1,402.63 | |||||
| Total common equity | 2,002.63 | |||||
| Total liabilities and equity | 4,061.20 | |||||
| Required return on bond (yield) | ||||||
| Par Value | $ 1,000.00 | |||||
| Number of bonds outstanding, in thousands | 1,000 | |||||
| Number of payments remaining | 52 | |||||
| Periodic coupon (semi-annual) | 40 | |||||
| Bond price now | $ 1,100.00 | |||||
| Aggregate market value of bonds, $millions | $ 1,100.00 | |||||
| Required return on stock | ||||||
| Beta | 1.2 | |||||
| Risk free rate | 4.00% | |||||
| Market risk premium | 6% | |||||
| Target weight debt | 30% | |||||
| Target weight equity | 70% | |||||
| Tax rate | 40% | |||||
| Common stock (million shares) | 100 | |||||
| Question: To evaluate your client's claim, design two valuation templates to show your client the valuation process. First assume a short horizon of three years. Then compare the results of this three-year horizon to a four-year forecasted horizon. You can use either FCF approach or EP approach to design the valuation templates. |
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