Chapter $12$ Mini Case Hatfield Medical Supplies?s stock price had been lagging its industry averages, so its board of directors brought in a new CEO, Jaiden Lee. Lee had brought in Ashley Novak, a finance MBA who had been working for a consulting company, to replace the old CFO, and Lee asked Ashley to develop the financial planning section of the strategic plan. In her previous job, Novak?s primary task had been to help clients develop financial forecasts, and that was one reason Lee hired her. Novak began as she always did, by comparing Hatfield?s financial ratios to the industry averages. If any ratio was substandard, she discussed it with the responsible manager to see what could be done to improve the situation. The following data shows Hatfield?s latest financial statements plus some ratios and other data that Novak plans to use in her analysis. Hatfield Medical Supplies: Balance Sheet $($Millions of Dollars$),12/31/2013$ Hatfield Medical Supplies: Income Statement $($Millions of Dollars Except per Share$)2013$ Cash $$20$ Sales $$2,000\mathrm{.}0$ Accts. rec. $$280$ Op$.$ costs $($excl$.$ depr.$)$ $$1,800\mathrm{.}0$ Inventories $$400$ Depreciation $$50\mathrm{.}0$ Total CA $$700$ EBIT $$150\mathrm{.}0$ Net fixed assets $$500$ Interest $$40\mathrm{.}0$ Total assets $$1,200$ Pretax earnings $$110\mathrm{.}0$ Taxes $(40\%)$ $$44\mathrm{.}0$ Accts. pay. & accruals $$80$ Net income $$66\mathrm{.}0$ Line of credit $$0$ Total CL $$80$ Dividends $$20\mathrm{.}0$ Long$-$term debt $$500$ Add. to RE $$46\mathrm{.}0$ Total liabilities $$580$ Common shares $10\mathrm{.}0$ Common stock $$420$ EPS $$6\mathrm{.}6$ Retained earnings $$200$ DPS $$2\mathrm{.}0$ Total common equ. $$620$ Ending stock price $$52\mathrm{.}80$ Total liab. & equity $$1,200$ Selected Ratios and Other Data, $2013$ Hatfield Industry Hatfield Industry Op$.$ costs$/$Sales $90\%88\%$ Total liability$/$Total assets $48\mathrm{.}3\%36\mathrm{.}7\%$ Depr.$/$FA $10\%12\%$ Times interest earned $3\mathrm{.}88\mathrm{.}9$ Cash$/$Sales $1\%1\%$ Return on assets $($ROA$)5\mathrm{.}5\%10\mathrm{.}2\%$ Receivables$/$Sales $14\%11\%$ Profit margin $($M$)3\mathrm{.}30\%4\mathrm{.}99\%$ Inventories$/$Sales $20\%15\%$ Sales$/$Assets $1\mathrm{.}672\mathrm{.}04$ Fixed assets$/$Sales $25\%22\%$ Assets$/$Equity $1\mathrm{.}941\mathrm{.}58$ Acc. pay. & accr. $/$ Sales $4\%4\%$ Return on equity $($ROE$)10\mathrm{.}6\%16\mathrm{.}1\%$ Tax rate $40\%40\%$ P$/$E ratio $8\mathrm{.}016\mathrm{.}0$ ROIC $8\mathrm{.}0\%12\mathrm{.}5\%$ NOPAT$/$Sales $4\mathrm{.}5\%5\mathrm{.}6\%$ Total op$.$ capital$/$Sales $56\mathrm{.}0\%45\mathrm{.}0\%$ Additional Data $2014$ Exp. Saled growth rate $10\%$ Interest rate on LT debt $8\%$ Target WACC $9\%$ a$.$ Using Hatfield?s data and its industry averages, how well run would you say Hatfield appears to be in comparison with other firms in its industry? What are its primary strengths and weaknesses? Be specific in your answer, and point to various ratios that support your position. Also, use the Du Pont equation $($see Chapter $3)$ as one part of your analysis. b$.$ Use the AFN equation to estimate Hatfield?s required new external capital for $2014$ if the sale growth rate is $10\%.$ Assume that the firm?s $2013$ ratios will remain the same in $2014.($Hint: Hatfield was operating at full capacity in $2013.)$ c$.$ Define the term capital intensity. Explain how a decline in capital intensity would affect the AFN, other things held constant. Would economies of scale combined with rapid growth affect capital intensity, other things held constant? Also, explain how changes in each of the following would affect AFN, holding other things constant: the growth rate, the amount of accounts payable, the profit margin, and the payout ratio. d$.$ Define the term self$-$supporting growth rate. What is Hatfield?s self$-$supporting growth rate? Would the self$-$supporting growth rate be affected by a change in the capital intensity ratio or the other factors mentioned in the previous question? Other things held constant, would the calculated capital intensity ratio change over time if the company were growing and were also subject to economies of scale and$/$or lumpy assets e$.$ Use the following assumptions to answer the questions below: $(1)$ Operating ratios remain unchanged. $(2)$ Sales will grow by $10\%,8\%,5\%,$ and $5\%$ for the next four years. $(3)$ The target weighted average cost of capital $($WACC$)$ is $9\%.$ This is the No Change scenario because operations remain unchanged. e$.(1)$ For each of the next four years, forecast the following items: sales, cash, accounts receivable, inventories, net fixed assets, accounts payable & accruals, operating costs $($excluding depreciation$),$ depreciation, and earnings before interest and taxes $($EBIT$).$ e$.(2)$ Using the previously forecasted items, calculate for each of the next four years the net operating profit after taxes $($NOPAT$),$ net operating working capital, total operating capital, free cash flow, $($FCF$),$ annual growth rate in FCF$,$ and return on invested capital. What does the forecasted free cash flow in the first year imply about the need for external financing? Compare the forecasted ROIC compare with the WACC. What does this imply about how well the company is performing? e$.(3)$ Assume that FCF will continue to grow at the growth rate for the last year in the forecast horizon $($Hint: $5\%).$ What is the horizon value at $2017?$ What is the present value of the horizon value? What is the present value of the forecasted FCF$?($Hint: use the free cash flows for $2014$ through $2017).$ What is the current value of operations? Using information from the $2013$ financial statements, what is the current estimated intrinsic stock price?