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		$2,000.0
Accts. rec.		$280		Op. costs (excl. depr.)		$1,800.0
Inventories		$400		Depreciation		$50.0
Total CA		$700		EBIT		$150.0
Net fixed assets		$500		Interest		$40.0
Total assets		$1,200		Pretax earnings		$110.0
				Taxes (40%)		$44.0
Accts. pay. & accruals		$80		Net income		$66.0
Line of credit		$0
Total CL		$80		Dividends		$20.0
Long-term debt		$500		Add. to RE		$46.0
Total liabilities		$580		Common shares		10.0
Common stock		$420		EPS		$6.6
Retained earnings		$200		DPS		$2.0
Total common equ.		$620		Ending stock price		$52.80
Total liab. & equity		$1,200
Selected Ratios and Other Data, 2013
		Hatfield	Industry			Hatfield	Industry
Op. costs/Sales		90%	88%	Total liability/Total assets		48.3%	36.7%
Depr./FA		10%	12%	Times interest earned		3.8	8.9
Cash/Sales		1%	1%	Return on assets (ROA)		5.5%	10.2%
Receivables/Sales		14%	11%	Profit margin (M)		3.30%	4.99%
Inventories/Sales		20%	15%	Sales/Assets		1.67	2.04
Fixed assets/Sales		25%	22%	Assets/Equity		1.94	1.58
Acc. pay. & accr. / Sales		4%	4%	Return on equity (ROE)		10.6%	16.1%
Tax rate		40%	40%	P/E ratio		8.0	16.0
ROIC		8.0%	12.5%
NOPAT/Sales		4.5%	5.6%
Total op. capital/Sales		56.0%	45.0%
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?