MFIN2235 Study Guide - Quiz Guide: Cash Flow, Net.

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24 Nov 2017

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First question is from last batch, but has relevance still for this quiz: consider a potential lbo of a company that will have cash flows of million every year. The lbo will take place for 10x cash flows with the same exit multiple, and assume a 3-year window for simplicity (exit is 3 years from today). Assume all extra cash flow is plowed back into the business at a 12% after tax return to cash flow. They are given a 20% carry on any profits above an 8% annual return. million in 5 years, what is the amount of the carry for the pe firm: a company has a pre-ipo value of million, and is considering raising million in an ipo in new funds (cash). What stake in the company will the new ipo shareholders have: consider a uniform price auction for 30 million shares, with the following investor interest.

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Meg Whalen, a financial analyst for Cheek Products, Inc., believes two major changes are needed at the company. First, she thinks that the company would be better off if it sold several divisions and concentrated on its core competencies in snack foods and security systems. Second, the company is financed entirely with equity. Because the cash flows of the company are relatively steady, Meg thinks the company's debt-equity ratio should be at least 0.25.

Meg has suggested a potential LBO to her partners, who have asked Meg to provide projections of the cash flows for the company. Here are Meg's estimates:

	2015	2016	2017	2018	2019
Sales	2,749	3,083	3,322	3,400	3,539
Costs	731	959	1,009	1,091	1,149
Depreciation	485	516	537	564	575
EBT	1,533	1,608	1,776	1,745	1,815
CapEx	279	242	304	308	304
Change in NWC	-122	-186	101	95	108
Asset Sales	1,419	1,028	n.a.	n.a.	n.a.

At the end of the five years, Meg estimates that the growth rate in cash flows will be 3.50% per year. The CapEx are for new projects and the replacement equipment that wears out. Additionally, the company would realize cash flow from the sale of several divisions. Even though the company will sell these divisions, overall sales should increase because of a more concentrated effort on the remaining divisions.

Meg is also aware that they will have to borrow a considerable amount of the purchase price. The interest payments on the debt for each of the next five years if the LBO is undertaken will be these (in millions):

	2015	2016	2017	2018	2019
Interest Payments	1,927	1,859	2,592	2,526	2,614

The company currently has a required return on assets of 14 percent. Because of the high debt level, the debt will carry a yield to maturity of 12.50% for the next five years. When the debt is refinanced in five years, they believe the new yield to maturity will be 8.00%. The company currently has 425 million shares of stock outstanding that sell for $29 per share. The corporate tax rate is 40%. If the partners decide to undertake the LBO, what is the most they should offer per share?

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An all equity firm generates cash flows (CFFA) of $100 million every year in perpetuity. Based on the risk of the cash flows, a discount rate of 20% is appropriate for the firm. The firm is considering a project that will require an investment of $75 million in one year. The project will generate cash flows of $10 million in perpetuity. The project is as risky as the firm and investment in the project will be made from cash generated by the firm. Therefore, dividends in one year will be reduced. The first cash flow will be received a year after making the investment. If the firm has 10 million shares outstanding, what is the stock price before the firm makes a decision to invest in the project? What will the stock price be if the firm announces that it has decided to take the project? Is the company making the right decision?

MNA is a retail store that operates through its stores across the USA. The following table (MNA Data as of end of 2016) shows data as of end 2016. BOD is a group considering LBO (leveraged buyout option) of MNA at the beginning of 2017. BOD is considering 25% equity and 75% debt. Group made the projections for 10 years (2017 through 2026) as shown below.

MNA Data as of end 2016

Debt on balance sheet $4,658 millions

Shareholders' equity at book value $3,524 millions

Market value of equity $6,300 millions

Market equity beta 0.88

Income tax rate 35%

BOD Assumptions

Debt 75%

Equity 25%

___________________________________________

Risk free rate 4.2%

Market risk premium 5%

Interest Rate 10%

Free cash flows to equity and debt holders (millions)

Year 2017	$778
Year 2018	$821
Year 2019	$864
Year 2020	$790
Year 2021	$754
Year 2022	$864
Year 2023	$859
Year 2024	$887
Year 2025	$945
Year 2026	$1,014

Questions:

a. Compute the unlevered market equity beta (asset beta) of MNA. Assume that the market value of debt is same as the book value.

b. Compute the cost of equity for BOD group with new capital structure. Risk free rate and market risk premium are provided in table BOD assumptions above.

c. Using the cost of equity calculated in question b, compute the weighted average cost of capital for BOD. Interest rate is provided in the table BOD assumptions.

d. Compute the present value of free cash flows to all debt and equity capital stakeholders at the weighted average cost of capital. Ignore the midyear adjustment. Assume that the free cash flows grow at 3% after 2026 for computing the continuing value.

e. Assume that BOD acquired MNA for the value calculated in d. Will BOD have the cash flows sufficient to pay the interest? Explain.

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MFIN2235 Study Guide - Quiz Guide: Cash Flow, Net.

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