3.

Consider the following 3-year projections for Boston Turkey Inc.:

Actual

Forecast

Year

2007

2008

2009

2010

EBIT

110

120

140

150

Depreciation

39

50

30

40

Increase in deferred taxes

6

4

2

3

Capital expenditures

50

60

75

85

Net working capital change

12

-10

5

-8

Corporate tax rate: 40%

The market risk premium is 5.5%. The 3-month Treasury bill rate is 1.00% and the 10-year Treasury bond rate is 4%.

The debt ratio is 50%

Interest coverage ratio (defined as EBIT-to-interest expense) is 3

After 2010, FCFs are expected to grow at 5%

The small company size premium is 0.5%

Using the information above, complete the following questions:

a) Calculate the free cash flows of Boston Turkey Inc. for the 3 years 2008 to 2010 (8 points)

b) Due to its limited history, the beta of the stock cannot be estimated from past prices. You do have information about comparable listed firms and their betas:

Firm

Equity Beta

Debt/Equity Ratio

Kentucky Fried Chicken

1.05

30%

Hardee's

1.20

50%

Popeye's Fried Chicken

0.90

60%

Roy Rogers

1.35

80%

The comparable firms all have the same tax rate as Boston Turkey (40%). Compute the average unlevered beta for comparables and calculate the cost of equity for Boston Turkey Inc. (12 points)

c) As general information, you have also collected data on interest coverage ratios, ratings and interest rate spreads, and they are summarized below:

Rating

Interest Coverage Ratio

Spread over T-bond

AAA

>9.65

0.30%

AA

6.85-9.65

0.70%

A+

5.65-6.85

1.00%

A

4.49-5.65

1.25%

A-

3.29-4.49

1.50%

BBB

2.76-3.29

2.00%

BB

2.17-2.76

2.50%

B+

1.87-2.17

3.00%

B

1.57-1.87

4.00%

B-

1.27-1.56

5.00%

CCC

0.87-1.27

6.00%

CC

0.67-0.87

7.50%

C

0.25-0.67

9.00%

What is the after-tax cost of debt for Boston Turkey Inc? (6 points)

d) Based on your calculation in part b) and c), what is the cost of capital? (5 points)

e) Compute the enterprise value (EV) as of year-end 2007. (10 points)

f) In 2008, Boston Turkeys book value of debt is 400 million, and book value of equity is $600 million. Estimate the economic value added (EVA) of the company in 2008. (6 points)

g) Assume now that you are the CEO of Boston Turkey and that your compensation next year will depend upon whether you increase the EVA or not. What are the three ways in which you can increase your EVA?