E14.5 Cost of capital calculations (revised) From the following data, calculate the cost of capital for operation (WACC). Use the capital asset pricing model to estimate the cost of equity capital. U.S. Government long-term bond rate Market risk premium Equity beta Per-share market price Shares outstanding Net financial obligations on balance sheet Weighted average borrowing cost Statutory tax rate 3.8% 5.0% 1.3 $35.50 58 million $1,750 million 7.5% 36.0% Explain why the cost of capital for operations is different from that for equity. E14.7 Residual operating income valuation, Nike, Inc., 2004 At the end of its 2004 fiscal year, the 263.1 million outstanding shares of Nike, Inc., traded at $75 each. The following summary numbers are from the 2004 financial report (in millions of dollars). Income statement Balance sheet 2004 2003 4,551 4,330 289 (302) Net operating assets Net financial assets Operating income Net financial expense 2004 961 16 a. Calculate the levered and unlevered (enterprise) price-to-book ratios at which Nike traded at the end of the fiscal year 2004. b. Calculate resid operating income for 2004 using beginning-of-year balance sheet amounts. Use a required return of 8.6 percent for operations. c. Calculate return on net operating (RNOA) assets for 2004. d. With this RNOA, forecast operating income and residual operating income for 2005. e. Calculate the value of a Nike share if the residual operating income you forecasted for 2005 is expected to grow at a 4 percent annual rate after 2005. E15.7 Simple valuation for the Coca-Cola Company In early 2006, the 2,369 million outstanding shares of the Coca-Cola Company traded at $48.91 each. The price-to-book ratio was 6.3 and the forward P/E was 19.3 based on analysts' consensus EPS forecast for 2007. An analyst extracted the following numbers from Coke's financial statements (in millions of dollars): Sales Core operating income, after tax Net operating assets (average for year) 2005 23,104 4,944 17,184 2004 21,742 4,870 16,563 2003 20,857 4,443 15,735 2002 19,564 4,324 14,932 a. Calculate the core operating profit margin and asset turnover for each year 2002-2005. b. Calculate the average sales growth rate over the years 2003-2005. c. The firm reported common shareholders' equity at the end of 2005 of $16,945 million, along with $1,010 million in net financial obligations. Using the numbers you calculated, estimate Coke's en- terprise value at the end of 2005 and also the value per share. Use a required return for operations of 10 percent. E15.9 A simple valuation and reverse engineering: IBM (revised) The following are key numbers from IBM's financial statements for 2004. Net operating assets, end of year Net financial obligations, end of year Common equity, end of year Common shares outstanding, end of year Core return on net operating assets Sales growth rate $42,104 million $12,357 million $29,747 million 1,645.6 million 21.0% 6.0% IBM's shares traded at $95 when 2004 results were announced. Use a required return for operations of 12.3 percent to answer the following questions: a. Forecast operating income and residual operating income for 2005 if IBM maintains the same core RNOA as in 2004. b. Calculate the per-share value of the equity if IBM were to maintain this profitability in the future and if residual earnings were to grow at the 2004 sales growth rate. Also calculate the implied forward enterprise P/E ratio and the enterprise P/B ratio. c. What growth rate in residual operating income would justify the current stock price if you were sure that 12.3 percent was a reasonable required return? E14.5 Cost of capital calculations (revised) From the following data, calculate the cost of capital for operation (WACC). Use the capital asset pricing model to estimate the cost of equity capital. U.S. Government long-term bond rate Market risk premium Equity beta Per-share market price Shares outstanding Net financial obligations on balance sheet Weighted average borrowing cost Statutory tax rate 3.8% 5.0% 1.3 $35.50 58 million $1,750 million 7.5% 36.0% Explain why the cost of capital for operations is different from that for equity. E14.7 Residual operating income valuation, Nike, Inc., 2004 At the end of its 2004 fiscal year, the 263.1 million outstanding shares of Nike, Inc., traded at $75 each. The following summary numbers are from the 2004 financial report (in millions of dollars). Income statement Balance sheet 2004 2003 4,551 4,330 289 (302) Net operating assets Net financial assets Operating income Net financial expense 2004 961 16 a. Calculate the levered and unlevered (enterprise) price-to-book ratios at which Nike traded at the end of the fiscal year 2004. b. Calculate resid operating income for 2004 using beginning-of-year balance sheet amounts. Use a required return of 8.6 percent for operations. c. Calculate return on net operating (RNOA) assets for 2004. d. With this RNOA, forecast operating income and residual operating income for 2005. e. Calculate the value of a Nike share if the residual operating income you forecasted for 2005 is expected to grow at a 4 percent annual rate after 2005. E15.7 Simple valuation for the Coca-Cola Company In early 2006, the 2,369 million outstanding shares of the Coca-Cola Company traded at $48.91 each. The price-to-book ratio was 6.3 and the forward P/E was 19.3 based on analysts' consensus EPS forecast for 2007. An analyst extracted the following numbers from Coke's financial statements (in millions of dollars): Sales Core operating income, after tax Net operating assets (average for year) 2005 23,104 4,944 17,184 2004 21,742 4,870 16,563 2003 20,857 4,443 15,735 2002 19,564 4,324 14,932 a. Calculate the core operating profit margin and asset turnover for each year 2002-2005. b. Calculate the average sales growth rate over the years 2003-2005. c. The firm reported common shareholders' equity at the end of 2005 of $16,945 million, along with $1,010 million in net financial obligations. Using the numbers you calculated, estimate Coke's en- terprise value at the end of 2005 and also the value per share. Use a required return for operations of 10 percent. E15.9 A simple valuation and reverse engineering: IBM (revised) The following are key numbers from IBM's financial statements for 2004. Net operating assets, end of year Net financial obligations, end of year Common equity, end of year Common shares outstanding, end of year Core return on net operating assets Sales growth rate $42,104 million $12,357 million $29,747 million 1,645.6 million 21.0% 6.0% IBM's shares traded at $95 when 2004 results were announced. Use a required return for operations of 12.3 percent to answer the following questions: a. Forecast operating income and residual operating income for 2005 if IBM maintains the same core RNOA as in 2004. b. Calculate the per-share value of the equity if IBM were to maintain this profitability in the future and if residual earnings were to grow at the 2004 sales growth rate. Also calculate the implied forward enterprise P/E ratio and the enterprise P/B ratio. c. What growth rate in residual operating income would justify the current stock price if you were sure that 12.3 percent was a reasonable required return