Consider HES Company’s financial statements given below. Assume the Company’s be
ID: 2745298 • Letter: C
Question
Consider HES Company’s financial statements given below. Assume the Company’s beta is estimated to be 1.5, risk free rate 2%, and market risk premium 10%. Furthermore, assume the company has a long-term growth rate for 2% after the fifth year and net income and comprehensive income will be identical.
What is the company's value using the following methods, for each method and part, provide your analysis and discussion.
a) Residual Income
b) Market to Book
c) Free Cash Flow to Equity (FCFE)
d) Free Cash Flow to Company (FCFC, Debt and Equity)
e) If Owners decide to issue 1,000,000 common shares (assume no floatation cost), how much would be the value for each share? Which valuation method would you prefer, why?
f) Analyze and explain which one of the above valuation methods provides a better and more realistic valuation, for an investor, an acquiring company, and a lender?
HES Company Financial Statements
Balance Sheets
HES Company Financial Statements
Income Statements Year +1 Year +2 Year +3 Year +4 Year +5 Revenues $1,976,000 $2,074,800 $2,178,540 $2,287,467 $2,401,840 Cost of Sales 1,213,659 1,274,342 1,338,059 1,404,962 1,475,210 Gross Profit $762,341 $800,458 $840,481 $882,505 $926,630 Accounting 6,000 6,300 6,615 6,946 7,293 Advertising & Promotion 15,000 12,360 12,731 13,113 13,506 Bank Charges 41,496 43,571 45,749 48,037 50,439 Compensation & Benefits 246,643 254,042 261,663 269,513 277,598 Consulting Fees 2,400 0 0 0 0 Insurance 1,000 1,050 1,103 1,158 1,216 Lease - Facilities 336,000 336,000 336,000 336,000 336,000 Legal & Professional 500 500 500 500 500 Licenses & Fees 500 510 520 531 541 Maintenance 600 612 624 637 649 Miscellaneous 1,800 1,836 1,873 1,910 1,948 Office supplies 2,700 2,754 2,809 2,865 2,923 Security 720 742 764 787 810 Telephone 1,800 1,836 1,873 1,910 1,948 Utilities 4,200 4,410 4,631 4,862 5,105 Website 1,800 1,800 1,800 1,800 1,800 Total Operating Exp. 663,159 668,323 679,255 690,569 702,276 EBIDTA $99,182 $132,135 $161,226 $191,936 $224,354 Depreciation 4,916 4,916 4,916 4,916 4,916 Operating Profit $94,266 $127,219 $156,310 $187,020 $219,438 Interest Expense 43,199 40,274 37,059 33,524 29,639 Earnings Before Taxes 51,067 86,945 119,251 153,496 189,799 Income Taxes 17,873 30,431 41,738 53,724 66,429 Net Income $33,194 $56,514 $77,513 $99,772 $123,370Explanation / Answer
Beta 1.5, risk free rate 2%, and market risk premium 10%
Market rate of return = Risk free rate + Beta (Market risk premium - risk free rate)
Market rate of return = 2% + 1.5(10%-2%)
Market rate of return = 14%
a.)
Residual Income is decreasing Year on year basis Because firm is raising equity capital for the year as a result Residual income will decrease as it is calculated by decreasing equity charge from residual Income.
B.) Market to Book value ratio requires Market value which is not given the book value is the value as given in the statement. Which are as per estimate are not comparable.
c.)
For this computation, take debt deducted by taking current year debt deducted by debt in the next year which will give you the amount of payment. This, value has increased highly which is alarming for the company. This is not good sign for the equity shareholders as they want the companies power to pay off after clearing off all debts, which is very bad.
d.)
As FCFE is reducing drastically as FCFE is negatively reducing at high level this shows that company has not much left over after it has paid all of its expenses, Including working capital and net capital expenditures.
Total Liabilities& Equity $592,631 $687,496 $736,382 $804,341 $892,378 Equity Charge = Total equity * Market rate of return computed using CAPM model $82,968 $96,249 $103,093 $112,608 $124,933 Net Income $33,194 $56,514 $77,513 $99,772 $123,370 Residual Income $49,774 $39,735 $25,580 $12,836 $1,563Related Questions
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