Donna Jamison, a 2006 graduate of the University of Florida with 4 years of valuing experience, was recently brought in as assistant to the chairperson of the board of D'Leon Inc., a small food producer that operates in north Florida and whose specialty is high-quality pecan and other nut products sold in the snack foods market. D'Leon's president, Al Watkins, decided a few years ago to undertake a major expansion and to "go national" in competition with Frito-Lay, Eagle, and other major snack foods companies. Watkins believed that D'Leon's products were of higher quality than the competition's; that this quality differential would enable it to charge a premium price; and that the end result would be greatly increased sales, profits, and stock price. The company has been growing at a very significant high rate and most analysts, including Donna, believe that the growth rate achieved this year will continue for 5 more years. However, this industry usually grows at the rate of the economy, so the analysts expect the company to grow with the economy in the long run. Further the company dividend policy is to pay 50 % of its earnings as dividends Donna hires you as a trainee, and you want to impress her with your knowledge in valuation. Your first task is to help Donna to estimate the value of the company. The company earning per share for the last five years are: 2015 $4.59 2013 2014 2012 2011 $4.03 $3.33 $3.59 $3.17 Financial Statements of D' Leon Inc. are attached. 1) What is the average growth rate for D'leon in the last 4 years? (you may report either arithmetic or geometric average) 2) What is the sustainable growth rate? (hint: g = ROE x retention ratio) 3) What is the 2015 dividend per share? 4) Estimate free cash flow to equity. 5) Estimate free cash flow to firm. 6) Calculate the current reinvestment rate. Donna has estimated the company's beta to be equal 1.20. The market risk premium is 5 % and the risk-free rate is 3 %. D'Leon market price is currently $80 per share, and its long term debt yields 5 %. Calculate cost of equity and cost of capital. 7) 8) The optimal capital structure for the snack industry is 30 % debt and 70% equity . Donna believes that the company should target this capital structure in the long-run. Under this condition, a. What is the long-run cost of capital? b. What is the long run reinvestment rate? Donna asks you to calculate the D'Leon price using the dividend discount approach, assuming 9) that company will grow at its sustainable growth rate for the next 5 years and then it will grow at the same rate of the industry (and the economy). 10) What is the intrinsic value using the free cash flow to equity aoproach? 11) What is the intrinsic value using the free cash flow to firm approach? (Assume the current reinvestment rate will be the same for the next 5 years, and then the company willl use the long- run reinvestment rate). 12) Are you surprised by the results? Is the company undervalued, overvalued, or fairly valued? Explain. 13) If you were an outside investor and the company announce that it will issue bonds to reach the optimal capital structure (the industry norm of using 30 % delt and 70 % equity). Would you buy the stock? Why? D'Leon Inc. Income Statement (in millions of dollars) 2015 Sales $214,000 Expenses excluding depreciation and amortization $170,000 EBITDA $44,000 $5,000 Depreciation and amortization $39,000 $750 Interest expense $38,250 $15,300 Taxes (40%) $22,950 Net Income $11,475 Common dividends $11,475 Addition to retained earnings Statement of Stockholders' Equity (in millions of dollars) $20,850 Balance of Retained Earnings, August 31, 2014 $22,950 -$11,475 Add: Net Income, 2015 Less: Common dividends paid, 2015 Balance of Retained Earnings, August 31, $32,325 2015 D'Leon Inc. Financial Statements (as of August 30, 2015) (in million of dollars) 2015 2014 Assets Cash and cash equivalents $13,000 $25,000 14,300 Accounts receivable $30,000 Inventories $28,125 $21,000 $59,000 Total current assets $72,425 Gross fixed assets $80,000 $71,000 Less accumulated depreciation $30,000 $25,000 $50,000 Net fixed assets $46,000 $122,425 $105,000 Total assets Liabilities and equity 59,000 S $10,800 Accounts payable 6,000 $7,600 Accruals $6,700 $5,150 Notes payable $20,150 $25,100 Total current liabilities $15,000 $14,000 $34,150 Long-term debt Total liabilities $40,100 50,000 $20,850 $70,850 $50,000 Common stock (5000 million shares) $32,325 $82,325 Retained Earnings Total common equity $105,000 $122,425 Total liabilities and equity Statement of Cash Flows (in millions of dollars) Operating Activities Net Income $22,950.0 Depreciation and amortization $5,000.0 Increase in accounts payable $1,800.0 Increase in aceruals $1,600.0 -$5,000.0 Increase in accounts receivable -$7,125.0 Increase in inventories Net cash provided by operating activities $19,225.0 Investing Activities -S9,000.0 Additions to property, plant, and equipment -$9,000.0 Net cash used in investing activities Financing Activities Increase in notes payable $1,550.0 $1,000.0 Increase in long-term debt $0.0 Increase in common stock -$11,475.0 Payment of common dividends -$8,925.0 Net cash provided by financing activities Summary $1,300.0 Net increase/decrease in cash $13,000.0 Cash balance at the beginning of the year $14,300.0 Donna Jamison, a 2006 graduate of the University of Florida with 4 years of valuing experience, was recently brought in as assistant to the chairperson of the board of D'Leon Inc., a small food producer that operates in north Florida and whose specialty is high-quality pecan and other nut products sold in the snack foods market. D'Leon's president, Al Watkins, decided a few years ago to undertake a major expansion and to "go national" in competition with Frito-Lay, Eagle, and other major snack foods companies. Watkins believed that D'Leon's products were of higher quality than the competition's; that this quality differential would enable it to charge a premium price; and that the end result would be greatly increased sales, profits, and stock price. The company has been growing at a very significant high rate and most analysts, including Donna, believe that the growth rate achieved this year will continue for 5 more years. However, this industry usually grows at the rate of the economy, so the analysts expect the company to grow with the economy in the long run. Further the company dividend policy is to pay 50 % of its earnings as dividends Donna hires you as a trainee, and you want to impress her with your knowledge in valuation. Your first task is to help Donna to estimate the value of the company. The company earning per share for the last five years are: 2015 $4.59 2013 2014 2012 2011 $4.03 $3.33 $3.59 $3.17 Financial Statements of D' Leon Inc. are attached. 1) What is the average growth rate for D'leon in the last 4 years? (you may report either arithmetic or geometric average) 2) What is the sustainable growth rate? (hint: g = ROE x retention ratio) 3) What is the 2015 dividend per share? 4) Estimate free cash flow to equity. 5) Estimate free cash flow to firm. 6) Calculate the current reinvestment rate. Donna has estimated the company's beta to be equal 1.20. The market risk premium is 5 % and the risk-free rate is 3 %. D'Leon market price is currently $80 per share, and its long term debt yields 5 %. Calculate cost of equity and cost of capital. 7) 8) The optimal capital structure for the snack industry is 30 % debt and 70% equity . Donna believes that the company should target this capital structure in the long-run. Under this condition, a. What is the long-run cost of capital? b. What is the long run reinvestment rate? Donna asks you to calculate the D'Leon price using the dividend discount approach, assuming 9) that company will grow at its sustainable growth rate for the next 5 years and then it will grow at the same rate of the industry (and the economy). 10) What is the intrinsic value using the free cash flow to equity aoproach? 11) What is the intrinsic value using the free cash flow to firm approach? (Assume the current reinvestment rate will be the same for the next 5 years, and then the company willl use the long- run reinvestment rate). 12) Are you surprised by the results? Is the company undervalued, overvalued, or fairly valued? Explain. 13) If you were an outside investor and the company announce that it will issue bonds to reach the optimal capital structure (the industry norm of using 30 % delt and 70 % equity). Would you buy the stock? Why? D'Leon Inc. Income Statement (in millions of dollars) 2015 Sales $214,000 Expenses excluding depreciation and amortization $170,000 EBITDA $44,000 $5,000 Depreciation and amortization $39,000 $750 Interest expense $38,250 $15,300 Taxes (40%) $22,950 Net Income $11,475 Common dividends $11,475 Addition to retained earnings Statement of Stockholders' Equity (in millions of dollars) $20,850 Balance of Retained Earnings, August 31, 2014 $22,950 -$11,475 Add: Net Income, 2015 Less: Common dividends paid, 2015 Balance of Retained Earnings, August 31, $32,325 2015 D'Leon Inc. Financial Statements (as of August 30, 2015) (in million of dollars) 2015 2014 Assets Cash and cash equivalents $13,000 $25,000 14,300 Accounts receivable $30,000 Inventories $28,125 $21,000 $59,000 Total current assets $72,425 Gross fixed assets $80,000 $71,000 Less accumulated depreciation $30,000 $25,000 $50,000 Net fixed assets $46,000 $122,425 $105,000 Total assets Liabilities and equity 59,000 S $10,800 Accounts payable 6,000 $7,600 Accruals $6,700 $5,150 Notes payable $20,150 $25,100 Total current liabilities $15,000 $14,000 $34,150 Long-term debt Total liabilities $40,100 50,000 $20,850 $70,850 $50,000 Common stock (5000 million shares) $32,325 $82,325 Retained Earnings Total common equity $105,000 $122,425 Total liabilities and equity Statement of Cash Flows (in millions of dollars) Operating Activities Net Income $22,950.0 Depreciation and amortization $5,000.0 Increase in accounts payable $1,800.0 Increase in aceruals $1,600.0 -$5,000.0 Increase in accounts receivable -$7,125.0 Increase in inventories Net cash provided by operating activities $19,225.0 Investing Activities -S9,000.0 Additions to property, plant, and equipment -$9,000.0 Net cash used in investing activities Financing Activities Increase in notes payable $1,550.0 $1,000.0 Increase in long-term debt $0.0 Increase in common stock -$11,475.0 Payment of common dividends -$8,925.0 Net cash provided by financing activities Summary $1,300.0 Net increase/decrease in cash $13,000.0 Cash balance at the beginning of the year $14,300.0