• The following information is given:

  Baseline (last year) sales: $250 million

  Sales growth rates: Base year = 15% with a fade rate of 1% a year for years 1-10: (increasing sales due to sustained competitive advantage and a differentiated product)[source: Strategic Plan]. Fade rate is the rate of decline per year (each year) from a base year.

  Sales growth rate in year 10 and forward: 5% (in year 11, the competition has caught up and the market has reached maturity) [source: Strategic Plan]

  Profit margin: Base year = 20%, with a fade rate of 1% a year for years 1-10: (during the period of competitive advantage, the firm can charge higher prices, but its profit margin slowly declines as competition increases) [source: Strategic Plan]

  Profit margin in year 10 and going forward: 10% [source: Strategic Plan]

  Fixed capital investment rate: 15% (for every dollar of new sales, we need an additional investment in fixed plant and equipment of $.15) [source: historical relationship]

  Working capital investment rate: 9% (for every dollar of new sales we need an additional investment in inventories and receivables of $.09) [source: historical relationship]

  Cash tax rate: 38% [source: historical relationship]

  Cost of capital: 11% [source: current yield on firm's debt and the cost of equity estimated using the Capital Asset Pricing Model, weighted average based on the target capital structure]

  Marketable securities: $20 million

  Market value of firm's debt: $50 million

  The firm has 5 million shares of common stock outstanding selling at:

  Scenario 1 = $50/share and

  Scenario 2 = $70/share.

  As indicated, the values assigned to drivers link directly to the strategic plan and the associated strategic analysis. In arriving at these estimates strategic alternatives have been evaluated for their value creation potential, with the set of strategies selected that create the most shareholder wealth.

  A template has been provided as an attachment -- fill in the shaded cells to answer the following four questions:

  What is the PV of operating cash flows over the competitive advantage period?

  What is the residual value of the firm after the period of competitive advantage?

  What is the value of the firm's equity?

  Compare the market value of equity ($50/share) with the estimate provided by SVA for scenario 1. What recommendations would you make to top management based on your analysis? Now compare the market value of equity ($70/share) with your SVA estimate. What would you recommend now?

  below is the copy of a template:

  Given:	($ '000)
  Base sales:	$250,000
  	Base year	Fade rate	Yr. 10 and after
  Sales growth:	1.15	0.01	1.05
  Operating PM	0.20	0.01	0.1
  Fixed capital inv rate	0.15
  WC inv rate	0.09		Note: Fade rate is the year-to-year reduction in the rate to some steady state rate
  Cash tax rate	0.38		Year 1 = 1.14, year 2 = 1.13, etc.
  COC	0.11
  Market securities	$20,000		Note: on a per $ of sales basis
  Debt	$50,000
  # shares outstanding	5,000,000
  					(all dollars in thousands)
  	Year1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7	Year 8	Year 9	Year 10	Residual
  Sales	$285,000	?	?	?	?	?	?	?	?	?	?
  Operating Profit	$54,150	?	?	?	?	?	?	?	?	?	?
  NOPAT	$33,573	?	?	?	?	?	?	?	?	?	?
  New Investment	$5,250	?	?	?	?	?	?	?	?	?	?
  Add'l WC	$3,150	?	?	?	?	?	?	?	?	?	?
  Free cash flow	$25,173	?	?	?	?	?	?	?	?	?	?
  PV to year 10		?
  Pv after year 10		?
  1. Value years 1-10		?
  2. Value after year 10		?
  Market securities		?
  Total Value		?
  Less debt		?
  3. Value of equity		?
  4. Value of equity/share		?

  
  

Answer rating: 100% (QA)

ANSWER To answer these questions well need to calculate the present value PV of operating cash flows over the competitive advantage period the residual value of the firm after the period of competitiv... View the full answer