Question

 

Case: Mini Case - Temp Force, Respond to Questions a, b, d, and e (1, 2, 3, 4).

Your employer, a midsized human resources management company, is considering expansion into related fields, including the acquisition of Temp Force Company, an employment agency that supplies word processor operators and computer programmers to businesses with temporarily heavy workloads. Your employer is also considering the purchase of Biggerstaff & McDonald (B&M), a privately held company owned by two friends, each with 5 million shares of stock. B&M currently has free cash flow of $24 million, which is expected to grow at a constant rate of 5%. B&M’s financial state-ments report short-term investments of $100 million, debt of $200 million, and preferred stock of $50 million. B&M’s weighted average cost of capital (WACC) is 11%. Answer the following questions:

a. Describe briefly the legal rights and privileges of common stockholders.

b. What is free cash flow (FCF)? What is the weighted average cost of capital? What is the free cash flow valuation model?

c. Use a pie chart to illustrate the sources that comprise a hypothetical company’s total value. Using another pie chart, show the claims on a company’s value. How is equity a residual claim?

d. Suppose the free cash flow at Time 1 is expected to grow at a constant rate of gL forever. If gL cash flows when discounted at the WACC? If the most recent free cash flow is expected to grow at a constant rate of gL , WACC), what is a formula for the present value of expected free cash flows when discounted at the WACC?

e. Use B&M’s data and the free cash flow valuation model to answer the following questions:

(1) What is its estimated value of operations?

(2) What is its estimated total corporate value? (This is the entity value.)

(3) What is its estimated intrinsic value of equity?

 

Answer 1

ANSWER:-

a)

The common stockholders square measure the homeowners of an organization, and per se, they need certain rights and privileges as represented below.1.Ownership implies management. Thus, a firm’s common stockholders have the proper to elect its firm’s administrators, UN agency successively elects the officers UN agency manage the business.2. Common stockholders typically have the proper, known as the preemption, to purchase any extra shares sold-out by the firm. In some states, the preemptive right is mechanically enclosed in each company charter; in others, it's necessary to insert it specifically into the charter.

b)

Free cash flow (FCF) represents the cash a company generates after accounting for cash outflows to support operations and maintain its capital assets. Unlike earnings or net income, free cash flow is a measure of profitability that excludes the non-cash expenses of the income statement and includes spending on equipment and assets as well as changes in working capital from the balance sheet.

Interest payments are excluded from the generally accepted definition of free cash flow. Investment bankers and analysts who need to evaluate a company’s expected performance with different capital structures will use variations of free cash flow like free cash flow for the firm and free cash flow to equity, which are adjusted for interest payments and borrowings.

Similar to sales and earnings, free cash flow is often evaluated on a per share basis to evaluate the effect of dilution.

c)

Total corporate value is the sum of the value of operations and the value of nonoperating assets. Some companies also have growth options but assume they are negligible for this company. Debt holders have the first claim. Preferred stockholders have the next claim. Any remaining value belongs to stockholders.

d)

Terminal value stock= (Expected FCFF * (1+g)) / (WACC - g)
Present value of FCFF= (Expected FCFF/ (1+r)^1)+ Terminal value/(1+r)
Present value of FCFF= FCFF* (1+r)/(1+r)^1+ Terminal Value/(1+r)

e)  

Use B&M’s data and the free cash flow valuation model to answer the following questions:
Free Cash Flow = 24,000,000
WACC = 11%
Growth rate (g) = 5%
Short term investments = 100,000,000
Debt Capital = 200,000,000
Preferred Stock = 50,000,000
Total No. of Outstanding Shares = 5,000,000 + 5,000,000 = 10,000,000

e1)

Value of the Firm = 24,000,000 *(1+0.05) / (0.11 - 0.05)
= $ 420,000,000

e2)

Total Value of the Firm = 420,000,000 + 100,000,000
= $ 520,000,000

e3)

Equity Value of the Firm = Total value of the firm - Total Debt - Total preferred Stock
= $ 520,000,000 - 200,000,000 - 50,000,000
= $ 270,000,000

e4)

Equity Value per share = 270,000,000 / 10,000,000
= $ 27.