Financial Questions

Problem 9-20

Sora
Industries has 60 million outstanding shares, $120 million in debt, $40
million in cash, and the following projected free cash flow for the next four
years:

Year

0

1

2

3

4

Earnings
and FCF Forecast ($ million)

1

Sales

433.0

468.0

516.0

547.0

574.3

2

Growth versus Prior Year

8.1%

10.3%

6.0%

5.0%

3

Cost of
Goods Sold

(313.6)

(345.7)

(366.5)

(384.8)

4

Gross
Profit

154.4

170.3

180.5

189.5

5

Selling,
General, and Administrative

(93.6)

(103.2)

(109.4)

(114.9)

6

Depreciation

(7.0)

(7.5)

(9.0)

(9.5)

7

EBIT

53.8

59.6

62.1

65.2

8

Less: Income Tax at 40%

(21.5)

(23.8)

(24.8)

(26.1)

9

Plus: Depreciation

7.0

7.5

9.0

9.5

10

Less: Capital Expenditures

(7.7)

(10.0)

(9.9)

(10.4)

11

Less: Increase in NWC

(6.3)

(8.6)

(5.6)

(4.9)

12

Free
Cash Flow

25.3

24.6

30.8

33.3

a.

Suppose
Sora’s revenue and free cash flow are expected to grow at a 5% rate beyond
year 4. If Sora’s weighted average
cost of capital is 10%, what is the value of Sora’s stock based on this
information?

b.

Sora’s
cost of goods sold was assumed to be 67% of sales. If its cost of goods sold
is actually 70% of sales, how would the estimate of the stock’s value change?

c.

Let’s
return to the assumptions of part (a) and suppose Sora can maintain its cost
of goods sold at 67% of sales. However, now suppose Sora reduces its selling,
general, and administrative expenses from 20% of sales to 16% of sales. What
stock price would you estimate now? (Assume no other expenses, except taxes,
are affected.)

d.

Sora’s
net working capital needs were estimated to be 18% of sales (which is their
current level in year 0). If Sora can reduce this requirement to 12% of sales
starting in year 1, but all other assumptions remain as in part (a), what
stock price do you estimate for Sora? (Hint: This change will have the
largest impact on Sora’s free cash flow in year 1.)

Problem 9-21

Consider
the valuation of Kenneth Cole Productions in Example 9.7.

a.

Suppose
you believe KCP’s initial revenue growth rate will be between 7% and 11%
(with growth slowing in equal steps to 4% by year 2011.) What range of share
prices for KCP is consistent with these forecasts?

b.

Suppose
you believe KCP’s EBIT margin will be between 7% and 10% of sales. What range
of share prices for KCP is consistent with these forecasts (keeping KCP’s
initial revenue growth at 9%)?

c.

Suppose
you believe KCP’s weighted average cost of capital is between 10% and 12%.
What range of share prices for KCP is consistent with these forecasts
(keeping KCP’s initial revenue growth and EBIT margin at 9%)?

d.

What
range of share prices is consistent if you vary the estimates as in parts
(a), (b), and (c) simultaneously?

Problem 9-23

Suppose
that in January 2006, Kenneth Cole Productions had EPS of $1.65 and a book
value of equity of $12.05 per share.

b.

What
range of share prices do you estimate based on the highest and lowest P/E
multiples in Table 9.1?

c. Using the average price to book value
multiple in Table 9.1, estimate KCP’s share price. d. What range of share prices do you
estimate based on the highest and lowest price to book value multiples in
Table 9.1?