Exhibit 6: Current Capital Markets Data as of 12/31/19 Source: Federal Reserve Board, Report H15 Selected...
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Exhibit 6: Current Capital Markets Data as of 12/31/19 Source: Federal Reserve Board, Report H15 Selected Interest Rates, FRED Economic Data, Federal Reserve Bank of St. Louis, Accessed 7/14/20. Debt betas are from "Capital Structure and Systematic Risk," by M. Schwert and I. Strebulaev, Appendix Table A1, Stanford Graduate School of Business, working paper, 4/6/14. Maturity 1-month 3-month 1-year 5-year 10-year 20-year 30-year Yield on US Treasury Securities 1.48% 1.55% 1.59% 1.69% 1.92% 2.25% 2.39% S&P Credit Rating AAA AA A BBB BB B CCC & Lower Credit Spread Over 10-Year US Treasury Yield 0.52% 0.53% 0.76% 1.29% 2.02% 3.56% 10.08% Estimated Debt Betas by Rating 0.04 0.05 0.05 0.10 0.24 0.31 0.43 Exhibit 8A: Financial Data on Firms that Manufacture or Purchase Hydraulic Equipment Source: Case writer analysis of data contained in S&P Capital IQ database, accessed 7/8/20. Firm Name (Ticker Symbol) Eaton Corp (ETN) Parker Hannifin (PH) Helios Technologies (HLIO) Enerpac Tool Group (EPAC) Caterpillar (CAT) Year Ending 12/31/19 S&P Operating Credit Assets Revenues Margins Rating $32,805 $21,390 $21,044 $1,022 $909 $78,453 $14,201 $555 $643 $53,800 13.3% 14.5% 17.0% 11.6% 15.1% A- BBB n/a BB A 2-Year Equity Betas (a) 1.09 1.42 1.72 1.51 1.52 Note a: The equity betas were calculated using two years of weekly returns regressed against returns on the S&P 500 Index. Noteb: The market value leverage ratios are the average quarterly ratio over two years starting 4017 and ending ending 4019 (9 observations). The net debt-to-value ratio = (Debt-Cash) / (Debt-Cash + Equity). It was calculated using the book value of debt and the market value of equity. Ma Leve t FINANCE 645 FINANCIAL MANAGEMENT Hint Sheet: Eaton Corporation Introduction In this case, you must use Discounted Cash Flow (DCF) techniques to assess the value of Eaton Corporation's hydraulics business and decide whether or not Eaton should accept Danfoss' offer to acquire it for $3.3 billion. The analysis will consist of two main parts. First, you will have to use data from comparable firms to estimate the cost of capital (i.e., discount rate). Second, you will use the Free Cash Flows (FCFs) for Eaton's hydraulics business to calculate their present value. The rest of this hint sheet will serve to guide you in more details. Fall 2022 Term 2 Assumptions Let us make the following assumptions for the valuation. Assume that time 0 is 2020. That is, the cash flows in 2021 are in year 1, the cash flows in 2022 are in year 2, and so on. . As stated in the case, assume that the corporate tax rate is 12.5%, which is the corporate tax rate in Ireland, where Eaton has been incorporated since 2012. I Use the S&P 500 as the market portfolio. . Note that the case uses Earnings Before Interest After Taxes (EBIAT) to refer to Unlevered Net Income (UNI). . Finally, while you should feel free to read the case's Appendix A on the weighted average cost of capital (it actually provides a nice overview), ignore the discussion about the impact of corporate taxes on the WACC discussed around equation (7). Cost of Capital The case's Exhibit 8A shows the comparable firms' equity betas estimated using two years of data. Since these regressions are typically done with five years of monthly data, you should recalculate these equity betas. For this purpose, the Exhibit and Data spreadsheet that is available from Canvas contains a "Historical Data" worksheet with five years of historical data on the four comparable firms, on the S&P 500, and on the Treasury Bill. . For each of the comparable firms, you are provided with the stock price at the end of every month between December 2014 and December 2019, as well as the monthly dividend for every month. You will need to calculate the monthly return series from these data. The Corporate Finance course will analyze this issue in detail. 1 onl Column S shows the return of the S&P 500 for each month, and column T shows the risk-free rate (from the Treasury Bill) that prevailed each month. Using these data, calculate the historical excess returns on each comparable firm and on the market portfolio, and estimate the comps' equity beta by performing a regression. Once you have estimated the equity beta for all four comparable firms, calculate the asset beta for each firm. To do so, you will need the debt-to-value ratio and debt beta for each firm. You can use the (market value) debt-to-value ratios from the case's Exhibit 8A. Note that the case uses net debt-to-value ratios, but you can use these ratios just like the debt-to-value ratios discussed in class. Net debt is debt minus cash; practitioners often use net debt, that is, subtract cash from debt, thereby assuming that the cash is not required to run the business and could be used to pay back part of the debt. To calculate each firm's debt beta, use the information about debt ratings in Exhibits 6 and 8A. Helios Technologies' debt is not rated; since its debt-to-value ratio is similar to that of Parker Hannifin, use that firm's debt rating. Finally, you can use the CAPM to estimate the cost of capital for Eaton's hydraulics division with the following assumptions. 1. Use Exhibit 6 for the risk-free rate; which maturity makes sense and why? 2. Assume that the market risk premium is rm -rf = 6.0%. Free Cash Flows Use the hydraulics division's free cash flows from Exhibit 5 as a starting point. Also, assume that the deal closes at time 0 (end of 2020) and so, like in the analysis in Exhibit 5, assume that the free cash flow in 2020 will not accrue to Danfoss (i.e., it should not be part of the division's value). Questions Your presentation should include an overview of the above analysis and address the following questions. 1. [Executive Summary] Given your DCF analysis, would you recommend that Eaton accepts Danfoss' offer? Why or why not? 2. Finance practitioners often assume that Bp is zero for comparable firms. When you do this (instead of using the assumptions above), what impact does this have on your valuation? 3. Suppose that Eaton accepts Danfoss' offer. Based on your DCF analysis, what is the internal rate of return of the investment made by Danfoss? 4. What growth rate of free cash flows in the terminal value calculation would justify Danfoss' offer? 2 Exhibit 6: Current Capital Markets Data as of 12/31/19 Source: Federal Reserve Board, Report H15 Selected Interest Rates, FRED Economic Data, Federal Reserve Bank of St. Louis, Accessed 7/14/20. Debt betas are from "Capital Structure and Systematic Risk," by M. Schwert and I. Strebulaev, Appendix Table A1, Stanford Graduate School of Business, working paper, 4/6/14. Maturity 1-month 3-month 1-year 5-year 10-year 20-year 30-year Yield on US Treasury Securities 1.48% 1.55% 1.59% 1.69% 1.92% 2.25% 2.39% S&P Credit Rating AAA AA A BBB BB B CCC & Lower Credit Spread Over 10-Year US Treasury Yield 0.52% 0.53% 0.76% 1.29% 2.02% 3.56% 10.08% Estimated Debt Betas by Rating 0.04 0.05 0.05 0.10 0.24 0.31 0.43 Exhibit 6: Current Capital Markets Data as of 12/31/19 Source: Federal Reserve Board, Report H15 Selected Interest Rates, FRED Economic Data, Federal Reserve Bank of St. Louis, Accessed 7/14/20. Debt betas are from "Capital Structure and Systematic Risk," by M. Schwert and I. Strebulaev, Appendix Table A1, Stanford Graduate School of Business, working paper, 4/6/14. Maturity 1-month 3-month 1-year 5-year 10-year 20-year 30-year Yield on US Treasury Securities 1.48% 1.55% 1.59% 1.69% 1.92% 2.25% 2.39% S&P Credit Rating AAA AA A BBB BB B CCC & Lower Credit Spread Over 10-Year US Treasury Yield 0.52% 0.53% 0.76% 1.29% 2.02% 3.56% 10.08% Estimated Debt Betas by Rating 0.04 0.05 0.05 0.10 0.24 0.31 0.43 Exhibit 6: Current Capital Markets Data as of 12/31/19 Source: Federal Reserve Board, Report H15 Selected Interest Rates, FRED Economic Data, Federal Reserve Bank of St. Louis, Accessed 7/14/20. Debt betas are from "Capital Structure and Systematic Risk," by M. Schwert and I. Strebulaev, Appendix Table A1, Stanford Graduate School of Business, working paper, 4/6/14. Maturity 1-month 3-month 1-year 5-year 10-year 20-year 30-year Yield on US Treasury Securities 1.48% 1.55% 1.59% 1.69% 1.92% 2.25% 2.39% S&P Credit Rating AAA AA A BBB BB B CCC & Lower Credit Spread Over 10-Year US Treasury Yield 0.52% 0.53% 0.76% 1.29% 2.02% 3.56% 10.08% Estimated Debt Betas by Rating 0.04 0.05 0.05 0.10 0.24 0.31 0.43 Exhibit 8A: Financial Data on Firms that Manufacture or Purchase Hydraulic Equipment Source: Case writer analysis of data contained in S&P Capital IQ database, accessed 7/8/20. Firm Name (Ticker Symbol) Eaton Corp (ETN) Parker Hannifin (PH) Helios Technologies (HLIO) Enerpac Tool Group (EPAC) Caterpillar (CAT) Year Ending 12/31/19 S&P Operating Credit Assets Revenues Margins Rating $32,805 $21,390 $21,044 $1,022 $909 $78,453 $14,201 $555 $643 $53,800 13.3% 14.5% 17.0% 11.6% 15.1% A- BBB n/a BB A 2-Year Equity Betas (a) 1.09 1.42 1.72 1.51 1.52 Note a: The equity betas were calculated using two years of weekly returns regressed against returns on the S&P 500 Index. Noteb: The market value leverage ratios are the average quarterly ratio over two years starting 4017 and ending ending 4019 (9 observations). The net debt-to-value ratio = (Debt-Cash) / (Debt-Cash + Equity). It was calculated using the book value of debt and the market value of equity. Ma Leve t Exhibit 8A: Financial Data on Firms that Manufacture or Purchase Hydraulic Equipment Source: Case writer analysis of data contained in S&P Capital IQ database, accessed 7/8/20. Firm Name (Ticker Symbol) Eaton Corp (ETN) Parker Hannifin (PH) Helios Technologies (HLIO) Enerpac Tool Group (EPAC) Caterpillar (CAT) Year Ending 12/31/19 S&P Operating Credit Assets Revenues Margins Rating $32,805 $21,390 $21,044 $1,022 $909 $78,453 $14,201 $555 $643 $53,800 13.3% 14.5% 17.0% 11.6% 15.1% A- BBB n/a BB A 2-Year Equity Betas (a) 1.09 1.42 1.72 1.51 1.52 Note a: The equity betas were calculated using two years of weekly returns regressed against returns on the S&P 500 Index. Noteb: The market value leverage ratios are the average quarterly ratio over two years starting 4017 and ending ending 4019 (9 observations). The net debt-to-value ratio = (Debt-Cash) / (Debt-Cash + Equity). It was calculated using the book value of debt and the market value of equity. Ma Leve t Exhibit 8A: Financial Data on Firms that Manufacture or Purchase Hydraulic Equipment Source: Case writer analysis of data contained in S&P Capital IQ database, accessed 7/8/20. Firm Name (Ticker Symbol) Eaton Corp (ETN) Parker Hannifin (PH) Helios Technologies (HLIO) Enerpac Tool Group (EPAC) Caterpillar (CAT) Year Ending 12/31/19 S&P Operating Credit Assets Revenues Margins Rating $32,805 $21,390 $21,044 $1,022 $909 $78,453 $14,201 $555 $643 $53,800 13.3% 14.5% 17.0% 11.6% 15.1% A- BBB n/a BB A 2-Year Equity Betas (a) 1.09 1.42 1.72 1.51 1.52 Note a: The equity betas were calculated using two years of weekly returns regressed against returns on the S&P 500 Index. Noteb: The market value leverage ratios are the average quarterly ratio over two years starting 4017 and ending ending 4019 (9 observations). The net debt-to-value ratio = (Debt-Cash) / (Debt-Cash + Equity). It was calculated using the book value of debt and the market value of equity. Ma Leve t FINANCE 645 FINANCIAL MANAGEMENT Hint Sheet: Eaton Corporation Introduction In this case, you must use Discounted Cash Flow (DCF) techniques to assess the value of Eaton Corporation's hydraulics business and decide whether or not Eaton should accept Danfoss' offer to acquire it for $3.3 billion. The analysis will consist of two main parts. First, you will have to use data from comparable firms to estimate the cost of capital (i.e., discount rate). Second, you will use the Free Cash Flows (FCFs) for Eaton's hydraulics business to calculate their present value. The rest of this hint sheet will serve to guide you in more details. Fall 2022 Term 2 Assumptions Let us make the following assumptions for the valuation. Assume that time 0 is 2020. That is, the cash flows in 2021 are in year 1, the cash flows in 2022 are in year 2, and so on. . As stated in the case, assume that the corporate tax rate is 12.5%, which is the corporate tax rate in Ireland, where Eaton has been incorporated since 2012. I Use the S&P 500 as the market portfolio. . Note that the case uses Earnings Before Interest After Taxes (EBIAT) to refer to Unlevered Net Income (UNI). . Finally, while you should feel free to read the case's Appendix A on the weighted average cost of capital (it actually provides a nice overview), ignore the discussion about the impact of corporate taxes on the WACC discussed around equation (7). Cost of Capital The case's Exhibit 8A shows the comparable firms' equity betas estimated using two years of data. Since these regressions are typically done with five years of monthly data, you should recalculate these equity betas. For this purpose, the Exhibit and Data spreadsheet that is available from Canvas contains a "Historical Data" worksheet with five years of historical data on the four comparable firms, on the S&P 500, and on the Treasury Bill. . For each of the comparable firms, you are provided with the stock price at the end of every month between December 2014 and December 2019, as well as the monthly dividend for every month. You will need to calculate the monthly return series from these data. The Corporate Finance course will analyze this issue in detail. 1 onl FINANCE 645 FINANCIAL MANAGEMENT Hint Sheet: Eaton Corporation Introduction In this case, you must use Discounted Cash Flow (DCF) techniques to assess the value of Eaton Corporation's hydraulics business and decide whether or not Eaton should accept Danfoss' offer to acquire it for $3.3 billion. The analysis will consist of two main parts. First, you will have to use data from comparable firms to estimate the cost of capital (i.e., discount rate). Second, you will use the Free Cash Flows (FCFs) for Eaton's hydraulics business to calculate their present value. The rest of this hint sheet will serve to guide you in more details. Fall 2022 Term 2 Assumptions Let us make the following assumptions for the valuation. Assume that time 0 is 2020. That is, the cash flows in 2021 are in year 1, the cash flows in 2022 are in year 2, and so on. . As stated in the case, assume that the corporate tax rate is 12.5%, which is the corporate tax rate in Ireland, where Eaton has been incorporated since 2012. I Use the S&P 500 as the market portfolio. . Note that the case uses Earnings Before Interest After Taxes (EBIAT) to refer to Unlevered Net Income (UNI). . Finally, while you should feel free to read the case's Appendix A on the weighted average cost of capital (it actually provides a nice overview), ignore the discussion about the impact of corporate taxes on the WACC discussed around equation (7). Cost of Capital The case's Exhibit 8A shows the comparable firms' equity betas estimated using two years of data. Since these regressions are typically done with five years of monthly data, you should recalculate these equity betas. For this purpose, the Exhibit and Data spreadsheet that is available from Canvas contains a "Historical Data" worksheet with five years of historical data on the four comparable firms, on the S&P 500, and on the Treasury Bill. . For each of the comparable firms, you are provided with the stock price at the end of every month between December 2014 and December 2019, as well as the monthly dividend for every month. You will need to calculate the monthly return series from these data. The Corporate Finance course will analyze this issue in detail. 1 onl FINANCE 645 FINANCIAL MANAGEMENT Hint Sheet: Eaton Corporation Introduction In this case, you must use Discounted Cash Flow (DCF) techniques to assess the value of Eaton Corporation's hydraulics business and decide whether or not Eaton should accept Danfoss' offer to acquire it for $3.3 billion. The analysis will consist of two main parts. First, you will have to use data from comparable firms to estimate the cost of capital (i.e., discount rate). Second, you will use the Free Cash Flows (FCFs) for Eaton's hydraulics business to calculate their present value. The rest of this hint sheet will serve to guide you in more details. Fall 2022 Term 2 Assumptions Let us make the following assumptions for the valuation. Assume that time 0 is 2020. That is, the cash flows in 2021 are in year 1, the cash flows in 2022 are in year 2, and so on. . As stated in the case, assume that the corporate tax rate is 12.5%, which is the corporate tax rate in Ireland, where Eaton has been incorporated since 2012. I Use the S&P 500 as the market portfolio. . Note that the case uses Earnings Before Interest After Taxes (EBIAT) to refer to Unlevered Net Income (UNI). . Finally, while you should feel free to read the case's Appendix A on the weighted average cost of capital (it actually provides a nice overview), ignore the discussion about the impact of corporate taxes on the WACC discussed around equation (7). Cost of Capital The case's Exhibit 8A shows the comparable firms' equity betas estimated using two years of data. Since these regressions are typically done with five years of monthly data, you should recalculate these equity betas. For this purpose, the Exhibit and Data spreadsheet that is available from Canvas contains a "Historical Data" worksheet with five years of historical data on the four comparable firms, on the S&P 500, and on the Treasury Bill. . For each of the comparable firms, you are provided with the stock price at the end of every month between December 2014 and December 2019, as well as the monthly dividend for every month. You will need to calculate the monthly return series from these data. The Corporate Finance course will analyze this issue in detail. 1 onl Column S shows the return of the S&P 500 for each month, and column T shows the risk-free rate (from the Treasury Bill) that prevailed each month. Using these data, calculate the historical excess returns on each comparable firm and on the market portfolio, and estimate the comps' equity beta by performing a regression. Once you have estimated the equity beta for all four comparable firms, calculate the asset beta for each firm. To do so, you will need the debt-to-value ratio and debt beta for each firm. You can use the (market value) debt-to-value ratios from the case's Exhibit 8A. Note that the case uses net debt-to-value ratios, but you can use these ratios just like the debt-to-value ratios discussed in class. Net debt is debt minus cash; practitioners often use net debt, that is, subtract cash from debt, thereby assuming that the cash is not required to run the business and could be used to pay back part of the debt. To calculate each firm's debt beta, use the information about debt ratings in Exhibits 6 and 8A. Helios Technologies' debt is not rated; since its debt-to-value ratio is similar to that of Parker Hannifin, use that firm's debt rating. Finally, you can use the CAPM to estimate the cost of capital for Eaton's hydraulics division with the following assumptions. 1. Use Exhibit 6 for the risk-free rate; which maturity makes sense and why? 2. Assume that the market risk premium is rm -rf = 6.0%. Free Cash Flows Use the hydraulics division's free cash flows from Exhibit 5 as a starting point. Also, assume that the deal closes at time 0 (end of 2020) and so, like in the analysis in Exhibit 5, assume that the free cash flow in 2020 will not accrue to Danfoss (i.e., it should not be part of the division's value). Questions Your presentation should include an overview of the above analysis and address the following questions. 1. [Executive Summary] Given your DCF analysis, would you recommend that Eaton accepts Danfoss' offer? Why or why not? 2. Finance practitioners often assume that Bp is zero for comparable firms. When you do this (instead of using the assumptions above), what impact does this have on your valuation? 3. Suppose that Eaton accepts Danfoss' offer. Based on your DCF analysis, what is the internal rate of return of the investment made by Danfoss? 4. What growth rate of free cash flows in the terminal value calculation would justify Danfoss' offer? 2 Column S shows the return of the S&P 500 for each month, and column T shows the risk-free rate (from the Treasury Bill) that prevailed each month. Using these data, calculate the historical excess returns on each comparable firm and on the market portfolio, and estimate the comps' equity beta by performing a regression. Once you have estimated the equity beta for all four comparable firms, calculate the asset beta for each firm. To do so, you will need the debt-to-value ratio and debt beta for each firm. You can use the (market value) debt-to-value ratios from the case's Exhibit 8A. Note that the case uses net debt-to-value ratios, but you can use these ratios just like the debt-to-value ratios discussed in class. Net debt is debt minus cash; practitioners often use net debt, that is, subtract cash from debt, thereby assuming that the cash is not required to run the business and could be used to pay back part of the debt. To calculate each firm's debt beta, use the information about debt ratings in Exhibits 6 and 8A. Helios Technologies' debt is not rated; since its debt-to-value ratio is similar to that of Parker Hannifin, use that firm's debt rating. Finally, you can use the CAPM to estimate the cost of capital for Eaton's hydraulics division with the following assumptions. 1. Use Exhibit 6 for the risk-free rate; which maturity makes sense and why? 2. Assume that the market risk premium is rm -rf = 6.0%. Free Cash Flows Use the hydraulics division's free cash flows from Exhibit 5 as a starting point. Also, assume that the deal closes at time 0 (end of 2020) and so, like in the analysis in Exhibit 5, assume that the free cash flow in 2020 will not accrue to Danfoss (i.e., it should not be part of the division's value). Questions Your presentation should include an overview of the above analysis and address the following questions. 1. [Executive Summary] Given your DCF analysis, would you recommend that Eaton accepts Danfoss' offer? Why or why not? 2. Finance practitioners often assume that Bp is zero for comparable firms. When you do this (instead of using the assumptions above), what impact does this have on your valuation? 3. Suppose that Eaton accepts Danfoss' offer. Based on your DCF analysis, what is the internal rate of return of the investment made by Danfoss? 4. What growth rate of free cash flows in the terminal value calculation would justify Danfoss' offer? 2 Column S shows the return of the S&P 500 for each month, and column T shows the risk-free rate (from the Treasury Bill) that prevailed each month. Using these data, calculate the historical excess returns on each comparable firm and on the market portfolio, and estimate the comps' equity beta by performing a regression. Once you have estimated the equity beta for all four comparable firms, calculate the asset beta for each firm. To do so, you will need the debt-to-value ratio and debt beta for each firm. You can use the (market value) debt-to-value ratios from the case's Exhibit 8A. Note that the case uses net debt-to-value ratios, but you can use these ratios just like the debt-to-value ratios discussed in class. Net debt is debt minus cash; practitioners often use net debt, that is, subtract cash from debt, thereby assuming that the cash is not required to run the business and could be used to pay back part of the debt. To calculate each firm's debt beta, use the information about debt ratings in Exhibits 6 and 8A. Helios Technologies' debt is not rated; since its debt-to-value ratio is similar to that of Parker Hannifin, use that firm's debt rating. Finally, you can use the CAPM to estimate the cost of capital for Eaton's hydraulics division with the following assumptions. 1. Use Exhibit 6 for the risk-free rate; which maturity makes sense and why? 2. Assume that the market risk premium is rm -rf = 6.0%. Free Cash Flows Use the hydraulics division's free cash flows from Exhibit 5 as a starting point. Also, assume that the deal closes at time 0 (end of 2020) and so, like in the analysis in Exhibit 5, assume that the free cash flow in 2020 will not accrue to Danfoss (i.e., it should not be part of the division's value). Questions Your presentation should include an overview of the above analysis and address the following questions. 1. [Executive Summary] Given your DCF analysis, would you recommend that Eaton accepts Danfoss' offer? Why or why not? 2. Finance practitioners often assume that Bp is zero for comparable firms. When you do this (instead of using the assumptions above), what impact does this have on your valuation? 3. Suppose that Eaton accepts Danfoss' offer. Based on your DCF analysis, what is the internal rate of return of the investment made by Danfoss? 4. What growth rate of free cash flows in the terminal value calculation would justify Danfoss' offer? 2
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