Capital Budgeting All figures are in millions unless otherwise stated A corporat
ID: 2669904 • Letter: C
Question
Capital BudgetingAll figures are in millions unless otherwise stated
A corporation is selling ABC company is to be sold.
ABC’s capital structure is 35% debt and 65% equity. Market value of capital is $6,300.0. The firm’s current cost of debt is 3.57% and cost of equity is 8.29%. The risk free rate is 2.25%, beta is 1.22, and the company’s tax rate is 42% including state and local taxes. Financial data is calculated using straight-line depreciation. ABC accounts for 44% of capital usage (of $6,300).
The deal structure includes the assumption of a $500.0 bond issue that matures in 2018, with a stated coupon rate of 5.5% and a current yield of 3.45%. It is anticipated the equity issue will be 100.0 shares.
ABC division generated sales of $950.0 this year and these are expected to grow at a 3.0% rate for the foreseeable future, ceteris paribus. Cost of goods sold has been steady at 68% of sales, and selling, general, and administrative expenses are expected to be about 12% of sales.
The sale will include transfer of the existing lease on the plant, which has 15 years remaining, and scheduled payments of $1.75 per year.
ABC also has patents with the following expected values and lives:
ABC Patents
2011 Book Value Remaining life (years)
Device A 250.00 7
Device B 175.00 9
Device C 340.00 10
Device D 125 .00 14
Device E 600.00 18
a. Find the current value of the ABC division based a 15 year time horizon and on the information above. You do not have to calculate a terminal value for the company in this step – just the present value of the 15 years.
b. ABC will need additional office space for housing administrative staff. Needs are projected to cost $260.00 thousand in 2012 and rents are increasing by 1.5% per year in this community. What impact will this have on the current value? What is the current value?
c. ABC expects to launch a new product in 2013 that will generate sales of $80.00 in the first year, with expected growth of 6% for the next 3 years, 4% for 2 years after that, and then 2% per year after that. What is the current value now? (Assume all of the above points remain the same)
d. Would it make sense to sell the company for this amount?
e. If you assumed ABC would grow at 2% per year after the initial 15 years, what would be the terminal value of the company in 2026? What would be the price per share after accounting for all of the above?
f. What is the expected Economic Value Added of ABC in 2012 assuming no additional capital investments?
Explanation / Answer
McDonald's Corporation (NYSE: MCD) is the world's largest chain of hamburger fast food restaurants, serving around 64 million customers daily in 119 countries.[3][4] Headquartered in the United States, the corporation was founded by businessman Ray Kroc in 1955 after he purchased the rights to a small hamburger chain operated by the eponymous Richard and Maurice McDonald.[5] A McDonald's restaurant is operated by either a franchisee, an affiliate, or the corporation itself. The corporation's revenues come from the rent, royalties and fees paid by the franchisees, as well as sales in company-operated restaurants. McDonald's revenues grew 27 percent over the three years ending in 2007 to $22.8 billion, and 9 percent growth in operating income to $3.9 billion.[6] McDonald's primarily sells hamburgers, cheeseburgers, chicken, french fries, breakfast items, soft drinks, shakes and desserts. In response to changing consumer tastes, the company has expanded its menu to include salads, wraps, smoothies and fruit.[7] The business began in 1940, with a restaurant opened by brothers Richard and Maurice McDonald in San Bernardino, California. Their introduction of the "Speedee Service System" in 1948 furthered the principles of the modern fast-food restaurant that the White Castle hamburger chain had already put into practice more than two decades earlier. The original mascot of McDonald's was a man with a chef's hat on top of a hamburger shaped head whose name was "Speedee." Speedee was eventually replaced with Ronald McDonald by 1967 when the company first filed a U.S. trademark on a clown shaped man having puffed out costume legs. McDonald's first filed for a U.S. trademark on the name McDonald's on May 4, 1961, with the description "Drive-In Restaurant Services," which continues to be renewed through the end of December 2009. In the same year, on September 13, 1961, the company filed a logo trademark on an overlapping, double arched "M" symbol. The overlapping double arched "M" symbol logo was temporarily disfavored by September 6, 1962, when a trademark was filed for a single arch, shaped over many of the early McDonald's restaurants in the early years. The famous double arched "M" symbol in use today did not appear until November 18, 1968, when the company filed a U.S. trademark. The first McDonald's restaurants opened in the United States, Canada, Costa Rica, Panama, Japan, the Netherlands, Germany, Australia, France, El Salvador and Sweden, in order of openings. The present corporation dates its founding to the opening of a franchised restaurant by Ray Kroc, in Des Plaines, Illinois, on April 15, 1955,[8] the ninth McDonald's restaurant overall. Kroc later purchased the McDonald brothers' equity in the company and led its worldwide expansion, and the company became listed on the public stock markets in 1965.[9] Kroc was also noted for aggressive business practices, compelling the McDonald brothers to leave the fast food industry. The McDonald brothers and Kroc feuded over control of the business, as documented in both Kroc's autobiography and in the McDonald brothers' autobiography. The site of the McDonald brothers' original restaurant is now a monument.[10] With the expansion of McDonald's into many international markets, the company has become a symbol of globalization and the spread of the American way of life. Its prominence has also made it a frequent topic of public debates about obesity, corporate ethics and consumer responsibility.
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