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RSM 333 (2015) – ASSIGNMENT #2Due Monday, August 10th, 2015 (4:00pm) at the Rotman Commerce OfficePlease submit a cover page. You will find the template on the course portal.The total available marks is 100. (Please show your work in detail.)Problem 1 – Cost of Capital (40 Marks)Please select from the list of companies below to complete this problem. In addition to the company’s investorrelations webpage you may use other finance-related resources (e.g. Yahoo! Finance).
GROUP A COMPANIES (Consumer Goods – Textile – Apparel Clothing)
Columbia Sportswear Company (COLM)o
Ralph Lauren Corporation (RL)o
Michael Kors Holdings Limited (KORS)o
GROUP B COMPANIES (Consumer Goods – Toys & Games and Entertainment – Diversified)
Mattel Inc. (MAT)o
Hasbro Inc. (HAS)o
The Walt Disney Company (DIS)o
Optional: You may refer to a past winning CFA Investment Research Challenge report for ideas.http://www.cfainstitute.org/community/challenge/about/Pages/past_champions.aspx
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RSM 333 (2015) – ASSIGNMENT #2Due Monday, August 10th, 2015 (4:00pm) at the Rotman Commerce OfficeComplete this problem twice by choosing 2 companies (i.e. 1 from Group A and 1 from Group B).You work in the corporate finance and treasury department and have just been assigned to the team estimatingthe company’s WACC. You must estimate this WACC in preparation for a team meeting later today. You quicklyrealize that the information you need is readily available online.1. Go to the Yahoo! Finance website, http://finance.yahoo.com/ . Under "Market Data," you will find theyield to maturity for 10-year treasury bonds. Collect this number as your risk-free rate.2. In the box, "Quote Lookup", type in the company’s ticker symbol and press enter. Once you see the basicinformation, find and click on "Key Statistics". From the key statistics, collect the information for thecompany’s market capitalization (its market value of equity), enterprise value (market-value equity + netdebt) (note: enterprise value is the total market value of a firm’s equity and debt, less the value of its cashand marketable securities), cash and beta.3. To get the cost of debt, you will need the yield to maturity on the firm’s existing long-term bonds. Go tothe Financial Industry Regulatory Authority’s website, www.finra.org , click on "Investors" and then, under"Market Data Center," click on "Bonds." Under "Search," click on "Corporate" and type in the tickersymbol. A list of the company’s outstanding bond issues will appear. Find the yield to maturity for yourchosen bond issue (i.e. close to 10 years from maturity) (it is in the column titled "Yield") and use this asyour pre-tax cost of debt. (Note: If this information is not available or hard to obtain with FINRA then useas a reference, comparable companies with similar credit ratings.)4. Compute the weights for equity and debt based on the market value of equity and market value of debt.5. Calculate the company’s cost of equity capital using the CAPM, the risk-free rate you collected, and amarket risk premium of 5%. If the company has preferred shares, you will need to consider cost ofpreferred shares.6. Assume that the company has a tax rate of 35%, calculate the effective (after-tax) cost of debt capital.7. Calculate the company’s WACC using the market value of equity and debt.8. Calculate the company’s net debt by subtracting its cash (collected in step 2) from its debt. Recalculatethe weights for the WACC using the market value of equity, net debt, and enterprise value (note:enterprise value is the total market value of a firm’s equity and debt, less the value of its cash andmarketable securities). Recalculate the company’s WACC using the weights based on the net debt. Howmuch does it change?9. How confident are you of your estimates in steps 7 and 8? Which implicit assumptions did you makeduring your data collection efforts?
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RSM 333 (2015) – ASSIGNMENT #2Due Monday, August 10th, 2015 (4:00pm) at the Rotman Commerce OfficeProblem 2 – Capital Structure and Dividend Irrelevance (20 Marks)ABC Inc. is an all-equity firm with no debt that is exempt from paying any taxes. The firm has CAD$100 thousandof assets (e.g. cash). It also expects to generate additional free cash flow of CAD$50 thousand per year intoperpetuity starting from next year (assume that the investment has already been made and accounted for in thevalue of existing assets). The cost of assets of ABC (cost of equity of the unlevered firm) is 10% and there are 20thousand shares outstanding. The Board of Directors of ABC is planning to use the CAD$50 thousand of its cash onthe balance sheet to either pay a special dividend or to repurchase the firm’s shares.1. What will be the percentage change in the share price of ABC on the ex-dividend date if ABC uses CAD$50thousand to pay a special dividend?2. If the firm uses CAD$50 thousand to repurchase some of its common stock and pays the entire free cashflow as regular dividends in the future, what would be the amount of such regular dividend per share?Now assume that the Board of Directors of ABC has decided to use the CAD$50 thousand of its cash on thebalance sheet to repurchase some of its common stock. You are an investor in ABC owning 5,000 shares of thefirm’s common stock. However, you are unhappy with the decision of ABC’s Board of Directors about the stockrepurchase and would have preferred that the firm used this money to pay a special dividend instead. You arealso unhappy with the fact that ABC is an all-equity firm and would have preferred that the firm had debt with the40% leverage ratio (as measured by D/V). The cost of debt (=interest rate) is 5%.3. Show exactly how you can create a homemade dividend to get the same combination of cash and stockafter the share repurchase as if ABC paid the special dividend.4. Show exactly how you can create homemade leverage to get the same leverage ratio with your holdingsas if the firm is levered as you had preferred (Hint: consider 3 different scenarios of perpetual annual cashflows (in thousands) starting in year 1: Recession: earnings=FCF=$40; Expected: earnings=FCF=$50; andExpansion: earnings=FCF=$60.)
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RSM 333 (2015) – ASSIGNMENT #2Due Monday, August 10th, 2015 (4:00pm) at the Rotman Commerce OfficeProblem 3 – Firm Valuation and M&A (40 Marks)(Consider using an Excel Spreadsheet to solve this problem.)You are the CFO of GreatFood, a large chain of grocery stores. You are planning to expand your business byacquiring the GoodWine winery that has recently been put up for sale by the owners. You think that thisacquisition may turn out to be a good investment so you want to have solid financial background for the deal topresent at the upcoming Shareholders Meeting on August 10th, 2015. You have the following information aboutthe GoodWine winery (the “Target”) and your firm (the “Acquirer”).GoodWine winery (“Target”)Some important accounting numbers projected for the next 5 years are as follows (all numbers are before-tax, asof the end of the fiscal year and in $ thousands):2016
Increase in NWCDepreciation
After year 5, the winery’s free cash flow (FCF) will grow at an annual rate of 3% into perpetuity. There are 200thousand shares outstanding. The market value of equity is currently $3,500 thousand and the market value ofoutstanding debt is $450 thousand (assume that the share price, the value of equity, and the value of debt aregiven at the valuation date, i.e. August 10th, 2015). The firm faces the (marginal) tax rate of 40%. The asset beta ofthe target (the beta of the same but all-equity firm) is 1.15.GreatFood (Acquirer)The acquirer expects to have the following estimated synergies from the M&A and all figures are before-tax, as ofthe end of the fiscal year and in $ thousands:SynergiesEBITDA
After year 5, the free cash flow (FCF) from synergies will grow at an annual rate of 2% into perpetuity. The firmfaces the (marginal) tax rate of 40%. The asset beta of the acquirer (the beta of the same but all-equity firm) is0.8.Note: The fiscal years of both your firm and the target end on August 10 (i.e. all projected numbers are given at theend of the fiscal year starting from exactly one year from the date of valuation).
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RSM 333 (2015) – ASSIGNMENT #2Due Monday, August 10th, 2015 (4:00pm) at the Rotman Commerce OfficeInformation about the deal/market conditionsThe target leverage (D/V) after the deal is completed is expected to be 25% (applies to both the target and thesynergies). The borrowing rate (cost of capital) is 8% and the Treasury bond rate (risk-free rate) is 5.5%. Themarket risk premium is 5%.1.1. What is the maximum price per share that your firm can pay for the target based on DCF and APV methods?You can build your analysis on the following steps in your valuation:a) Estimate the value of the levered target firm:a. Calculate the cost of assets (unlevered equity return, i.e. cost of equity of the same but all-equityfirm) for the target using CAPMb. Calculate the cost of equity (levered equity return) for the targetc. Calculate the weighted average cost of capital (WACC) for the targetd. Estimate free cash flow (FCF) for years 2016-2020e. Calculate the terminal value in 2020 using the APV method and the WACC method separatelyf. Calculate the value of the levered target firm using the APV method (Hint: since leverage isexpected to change, D*t is not an appropriate way of estimating tax shields – derive tax shieldsfrom the relation between the levered and unlevered values of the firm)g. Calculate the value of the levered target firm using the WACC methodb) Calculate the value of synergies:a. Calculate the cost of assets for the acquirer using CAPMb. Calculate the cost of equity (levered equity return) for the acquirerc. Calculate the weighted average cost of capital (WACC) for the acquirerd. Estimate free cash flow (FCF) from synergies for years 2016-2020 using beta and growth rate ofthe acquirere. Calculate the terminal value of synergies in 2020 using the APV method and the WACC methodseparatelyf. Calculate the value of the levered synergies using the APV method (do not forget about the taxshields)g. Calculate the value of the levered synergies using the WACC methodc) Find the value of the target’s equity to the acquirer:a. Calculate the value of the levered target to the acquirer by adding the value of synergies to thevalue of the levered target firmb. Subtract the amount of outstanding debt to get the value of equityd) Calculate the maximum price per share that the acquirer can pay for the target1.2. If your firm announces the deal on August 10th, 2015, what is the expected return on the target’s equity at theannouncement (based on both DCF and APV methods)?
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RSM 333 (2015) – ASSIGNMENT #2Due Monday, August 10th, 2015 (4:00pm) at the Rotman Commerce OfficeHint: The following relationship will be useful for you in Problem 3.
DDPV (TS ) VL TC and VL VU PV (TS ) => PV (TS ) VU PV (TS ) TCVVLLDDDDTC PV (TS ) TC => 1 TC PV (TS ) VU TC
=> PV (TS ) VU
DVU TCVL=> PV (TS )D1 TCVL
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Finance-RSM 333 (2015) – ASSIGNMENT #2
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