Chapter 13.

Solution for 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)
Dividends per share
Balance Sheets for December 31 (Millions of Dollars)
Assets
Cash
Marketable Securities
Accounts receivable
Inventories
Total current assets
Net plant and equipment
Total Assets

10
3.11

2010
8.0
20.0
80.0
160.0
268.0
600.0

Liabilities and Equity

Accounts Payable
Notes payable
Accruals
Total current liabilities
Long-term bonds
Preferred stock
Common Stock

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
Sales Growth Rate
Costs / Sales
Depreciation / Net PPE

Actual
2010

Projected
2011

Projected
2012

Projected
2013

72%
10%

15%
72%
10%

10%
72%
10%

6%
72%
10%

Cash / Sales
Acct. Rec. / Sales
Inventories / Sales
Net PPE / Sales
Acct. Pay. / Sales
Accruals / Sales
Tax rate
Weighted average cost of capital (WACC)

1%
10%
20%
75%
2%
5%
40%
10.5%

1%
10%
20%
75%
2%
5%
40%
10.5%

1%
10%
20%
75%
2%
5%
40%
10.5%

1%
10%
20%
75%
2%
5%
40%
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
2010
Net Sales
Costs (except depreciation)
Depreciation
Total operating costs
Earning before int. & tax

$
$
$
$
$

800.0
576.0
60.0
636.0
164.0

Projected
2011
$
$
$
$
$

920.0
662.4
69.0
731.4
188.6

Projected
2012
$
$
$
$
$

1,012.0
728.6
75.9
804.5
207.5

Projected
2013
$
$
$
$
$

1,072.7
772.4
80.5
852.8
219.9

Partial Balance Sheets for December 31 (Millions of Dollars)

Actual
2010

Operating Assets

Projected
2011

Projected
2012

Projected
2013

Cash
Accounts receivable
Inventories
Net plant and equipment

$
$
$
$

8.0
80.0
160.0
600.0

$
$
$
$

9.2
92.0
184.0
690.0

$
$
$
$

10.1
101.2
202.4
759.0

$
$
$
$

10.7
107.3
214.5
804.5

Operating Liabilities
Accounts Payable
Accruals

$
$

16.0
40.0

$
$

18.4
46.0

$
$

20.2
50.6

$
$

21.5
53.6

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
248.0
285.2
313.7
332.5
Operating current liabilities
56.0
64.4
70.8
75.1
Net operating working capital
192.0
220.8
242.9
257.5
Net PPE
600.0
690.0
759.0
804.5
Net operating capital
792.0
910.8
1,001.9
1,062.0
NOPAT
98.4
113.2
124.5
131.9
Investment in operating capital
na
118.8
91.1
60.1
Free cash flow
na
(5.6)
33.4
71.8
Growth in FCF
na
na
-692.1%
115.1%
Growth in sales
15.0%
10.0%
6.0%

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)?

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
2010

Projected
2011

Operating profitability
(OP=NOPAT/Sales)
12.3%
12.3%
Capital requirement
(CR=Operating capital/Sales)
99.0%
99.0%
Return on invested capital
(ROIC=NOPAT/Operating capital at
start of year)
na
14.3%
Weighted average cost of capital (WACC)
na
10.5%
Spread between ROIC and WACC
na
3.8%
Yes, because the spread is positive, the company should have a positive MVA.

Projected
2012

Projected
2013

12.3%

12.3%

99.0%

99.0%

13.7%
10.5%
3.2%

13.2%
10.5%
2.7%

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
2010
Free cash flow
Long-term constant growth in FCF
Weighted average cost of capital (WACC)
Horizon value
FCF in Years 1-3 and FCF4 + horizon value in Year 4
Value of operations (PV of FCF + HV)

(5.6)
10.5%

10.5%
(5.6)

1,329.6

Operating capital

792.0

Market value added (MVA=Market value of

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

537.6

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

Projected
2011

1,329.6
20.0
1,349.6
340.0
15.0
994.6
10
99.5

Projected
2012

Projected
2013

33.4

71.8

10.5%

10.5%

33.4

71.8

4/11/2010

ces. 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%

flow.

Projected
2014
$
$
$
$
$

1,137.1
818.7
85.3
904.0
233.1

Projected
2014
$
$
$
$

11.4
113.7
227.4
852.8

$
$

22.7
56.9

flow each year to ensure

forecast period.
Projected
2014
352.5
79.6
272.9
852.8
1,125.7
139.9
63.7
76.1
6.0%
6.0%

pital/Sales), and return

between ROIC and
value of company - book

pital/Sales), and return

between ROIC and
value of company - book

Projected
2014
12.3%
99.0%

13.2%
10.5%
2.7%

of the forecast period,

l growth rate beyond the
Projected
2014
76.1
6.0%
10.5%
1,793.6
1,869.7