Strategic Financial Management
Project #1
PROJECT #1: Equity Instruments
1. You have been asked to estimate the cost of equity for Hadley Holdings, a firm with operations in three different businesses – retailing, hotels, and travel. You have collected information on the firm’s operations and of comparable firms in each of the businesses.
Comparable Firms
|
Revenues |
Unlevered Beta |
Firm Value/Sales |
|
| Retailing |
$400 Million |
0.85 |
2.0 |
| Software |
$400 Million |
1.15 |
3.0 |
| Travel |
$800 Million |
1.35 |
1.25 |
Estimate the bottom-up unlevered beta for Hadley Holdings. ( 20 points)
Hadley Holdings has no market-traded debt. The firm does, however, have $ 1.2 billion in book debt and an interest expense of $ 60 million. If the debt has an average maturity of 5 years, and the fair market rate for debt for the firm is 7%, estimate the market value of the debt. ( 20 points)
Hadley Holdings has 100 million shares outstanding trading at $ 10 a share. In conjunction with the estimated market value of debt in (b), estimate the bottom-up levered beta for the firm. (You can assume a marginal tax rate of 40%.) ( 10 points)
2. Now assume that you have been asked to estimate the free cash flow to the firm last year
for Hadley Holdings and have collected the following information.
• The firm reported earnings before interest, taxes, depreciation, and amortization of $350 million on its revenues of $ 1600 million.
• Depreciation and amortization charges amounted to $ 100 million and capital expenditures were $ 200 million.
• Hadley spent $ 100 million last year on research and development in its software division, following R&D expenditures of $ 60 million (3 years ago), $ 75 million (2 years ago), and $ 90 million (1 year ago) in the prior three years. You believe that research expenditures have an amortizable life of 3 years.
• The working capital items for the last year and the previous year are reported below.
|
Last Year |
Year Before Last |
|
| Cash | $100 Million | $80 Million |
| Accounts Receivable | $80 Million | $90 Million |
| Inventory | $150 Million | $100 Million |
| Accounts Payable | $130 Million | $110 Million |
| Short-Term Debt | $150 Million | $130 Million |
• The tax rate for the firm is 40%.
a. Estimate the value of the research asset of the firm. ( 10 points)
b. Estimate the operating income adjusted for R&D expenditures. (10 points)
c. Estimate the free cash flows to the firm last year. ( 30 points)
Answer all questions and show the necessary work. Please be brief. This is an open book and open notes exam