Buckeye Computer Valuation

Buckeye Computer, Inc. is introducing a new line of image generators and visual workstations at the beginning of 2006. BCIs revenues should grow by 15% per year through 2010. The line should yield operating profit margins of 14%.

Because of rapid technological change in the industry, the product life cycle of the workstations is no more than 5 years. At the beginning of 2011, BCI will introduce a second generation of workstations with fully-integrated image generators based on research already under way. The second line is predicted, on average, to yield growth in revenue of 6% and operating profit margins of 12% starting in 2011 and lasting into the indefinite future. Other target ratios for BCI are given in Exhibit 2. BCI's financial statements are given in Exhibit 1.

The project you will be evaluating is the purchase of Buckeye Computer whose equity currently has a market value of approximately $2,900 million (50 million shares at $58 each).

1. (20pts) What are the expected free cash flows for Buckeye for each year from 2006 through 2010?

2. (20pts) Careful analysis of Buckeye's strategy, its markets and its dependence on outside sources of funding, software writers, customers, etc., suggests prudent worst case interest coverage (i.e., coverage that would not significantly impair operations) for Buckeye is 3. Under these circumstances, Buckeye should be able to borrow at a long-term interest rate of about 8.0%per year. What debt to total capital ratio is appropriate for financing the purchase of BCI?

At the beginning of 2006, the rate of interest on risk free 30-day treasury bills is 4.8%. The yield on 30-year treasury bonds is 6.2%. The stock of companies which have only negligible debt and produce high performance computers are trading at price-earnings multiples (price to most recent earnings) of about 12 and have equity betas of 1.0. Buckeye itself has a beta of 1.05 and a price-earnings ratio of 11.7.

3. (20pts) What is the appropriate beta for Buckeye post-purchase? What is the beta-based estimate of the cost of equity capital for the purchase of Buckeye? What is Buckeye's weighted average cost of capital, i.e., the discount rate for evaluating the purchase? Explain your calculations.

4. (20pts) Determine the expected residual value at the end of 2010 for Buckeye as a going concern with the techniques below:

a. Using the perpetuity with growth model, what is Buckeye's expected residual value?

b. What residual value would be appropriate if you forecast Buckeye will face very competitive market conditions after 2010?

c. Using a multiple of income approach (e.g., an EBIT or a P/E multiple), what residual value would you estimate?

d. Which of the three is most appropriate to use in this case (given the data available)?

Carefully explain the rationale for your answer.

5. (10pts) What is your valuation of Buckeye Computers and the value per share of its equity?

6. (10pts) How does this compare to the current market price per share? How might you explain the discrepancy? Explain.

EXHIBIT 1
BUCKEYE COMPUTERS, INC.
($ millions)
Income Statement		2001	2002	2003	2004	2005
	Sales	1,604	1,950	2,240	2,456	3,017
	Cost of Goods Sold	842	1,020	1,226	1,517	1,739
	R&D Expense	158	203	240	278	327
	SG&A Expense	367	446	479	522	549
	Operating Income (EBIT)	237	281	295	139	402
	Interest Expense	8	6	5	13	14
	Earnings before Tax	229	275	290	126	388
	Income Taxes	85	108	107	40	141
	Earnings (NI)	144	167	183	86	247
	Dividends	0	18	28	45	49
	to Retained Earnings	144	149	155	41	198
Balance Sheet		2001	2002	2003	2004	2005
	Cash	103	58	45	17	30
	Accounts Receivable	219	283	328	349	431
	Inventory	282	348	420	500	584
	Other Current Assets	18	22	24	28	32
	Current Assets	622	711	817	894	1,077
	Plant, Property & Equipment (net)	410	482	536	610	686
	Other Fixed Assets	32	39	45	49	61
	Total Assets	1,064	1,232	1,398	1,553	1,824
	Accounts Payable	145	177	203	233	285
	Accrued Expenses	30	32	34	18	31
	Short Term Debt	41	31	19	124	35
	Current Liabilities	216	240	256	375	351
	Long Term Debt	55	50	45	40	137
	Net Worth	793	942	1,097	1,138	1,336
	Liabilities & Net Worth	1,064	1,232	1,398	1,553	1,824
Notes:	CAPEX (PP&E only)		97	97	106	120
	Depreciation (PP&E only)		25	43	32	44

EXHIBIT 2
BUCKEYE COMPUTER, INC.
Projected Ratios for Future Operation
Ratio	Projected Level
Cash/Sales	1%
Accounts Receivable/Sales	14%
Inventory/Sales	18%
Other Current Assets/Sales	1%
Accounts Payable/Sales	9%
Accrued Expenses/Sales	1%
Net Working Capital/Sales	24%
Net PP&E/Sales	23%
Other Fixed Assets/Sales	2%
Net Fixed Assets/Sales	25%
Tax Rate	35%
Dividends/Net Income	20%