Hello,

Require responses to questions within assignment 2 of the Clarkson Lumber case attached.

Best Regards,

John

Ex_1 Exhibit 1 Operating Expenses for Years Ending December 31, 1993-1995, and for First Quarter 1996 (thousands of dollars) Net sales Cost of Goods Sold: Beginning inventory Purchases Ending inventory Total Cost of Goods Sold Gross profit Operating expensesb Earnings before interest and taxes Interest expense Net income before income taxes Provision for income taxesc Net income 1993 $2,921 1994 $3,477 1995 $4,519 330 2,209 $2,539 337 $2,202 719 622 $97 23 $74 14 $60 337 2,729 $3,066 432 $2,634 843 717 $126 42 $84 16 $68 432 3,579 $4,011 587 $3,424 1,095 940 $155 56 $99 22 $77 1st Quarter 1996 $1,062 a 587 819 $1,406 607 $799 263 244 $19 13 $6 1 $5 In the first quarter of 1995, sales were $903,000 and net income was $7,000. Operating expenses include a cash salary for Mr. Clarkson of $75,000 in 1993; $80,000 in 1994; a b $85,000 in 1995; and $22,500 in the first quarter of 1996. Clarkson Lumber was required to estimate its income tax liability for the current tax year and pay four c quarterly estimated tax installments during that year. The first $50,000 of pretax profits were taxed at a 15% rate; the next $25,000 were taxed at a 25% rate; the next $25,000 were taxed at a 34% rate; and profits in excess of $100,000 but less than $335,000 were taxed at a 39% rate. Page 1 Ex_1 and pay four Page 2 Ex_2 Exhibit 2 Balance Sheets at December 31, 1993-1995, and March 31, 1996 (thousands of dollars) 1st Quarter 1993 1994 1995 1996 Cash $43 $52 $56 $53 Accounts receivable, net 306 411 606 583 Inventory 337 432 587 607 Current assets $686 $895 $1,249 $1,243 Property, net 233 262 388 384 Total Assets $919 $1,157 $1,637 $1,627 Notes payable, banka Note payable to Holtz, current portionb Notes payable, trade Accounts payable Accrued expenses Term loan, current portionc Current liabilities Term loanc Note payable, Mr. Holtzb Total Liabilities Net worth Total Liabilities and Net Worth $ ---213 42 20 $275 140 -$415 504 $919 60 100 -340 45 20 $565 120 100 $785 372 $1,157 390 100 127 376 75 20 $1,088 100 0 $1,188 449 $1,637 399 100 123 364 67 20 $1,073 100 0 $1,173 454 $1,627 Interest is computed on the average outstanding loan balance at the rate of prime plus 2 1/2%. Interest is fixed at 11% times the outstanding balance. c Interest is fixed at 10.0% times the outstanding balance; the term loan is secured by the fixed assets a b and is repayable in semiannual installments of $10,000. Page 3 Ex_2 Page 4 CLARKSON LUMBER - Assignment 1 Keith Clarkson, sole owner and president of the Clarkson Lumber Company, has received a number of informal inquiries from large, nationally-recognized building materials distributors about purchasing his company. Although Clarkson relishes operating his own business the would be interested if an attractive offer were received. Unfortunately, Mr. Clarkson is unsure how much his company is worth so he turns to you for guidance. Your end goal, in assignment 1, is to value Clarkson Lumber operations at the beginning of 1996, that is to value its operating assets at the end of 1995 based on the free cash flows they are going to generate from 1996 to infinity. You will assume the firm will obtain a credit line at Northrup National Bank sufficiently large to take advantage of discounts on purchases for paying within 10 days of invoice, thus increasing operating profit margins. With higher mark-ups and continued operating expense controls, Clarkson projects a steady operating profit margin of 6% by 2000. Margins and investment requirements will also stabilize in relation to sales growth. Relevant projection inputs are in the table below and the discount rate is 11.5%. Note that the forecast ratios already include the benefit the of the 2% trade discounts. For simplicity, use a tax rate of 35% throughout the projections. Make whatever other reasonable assumptions are necessary to complete your analysis and explain the rationale for each. Projection Assumptions Sales Sales growth rate COGS/Sales Op Exp/Sales OPM Tax rate AR DOH (= AR/daily sales) Inv DOH (=inventory/daily COGS) NFATO (@Sales) (= sales/NFA) AP DOH (AP/daily purchases) Acc Exp/Sales avg 93-95 1997 1998 1999 24.5% 75.6% 20.9% 3.5% 20.5% 1996 5,500 21.7% 75.0% 20.4% 4.6% 35% 20% 74.0% 20.0% 6.0% 35% 15% 74.0% 20.0% 6.0% 35% 10% 74.0% 20.0% 6.0% 35% 43.4 59.4 12.5 39.7 1.46% 43.4 59.4 12.5 10 1.46% 43.4 59.4 12.5 10 1.46% 43.4 59.4 12.5 10 1.46% 43.4 59.4 12.5 10 1.46% 1 - Project free cash flows for the next five years, 1996 to 2000 (please refer to video 25 to get the FCF in 1996) 2 - Use the same assumptions as in 2000 in order to compute the FCF of 2001, 2002 and 2003. Then, see if they follow a constant growth pattern year on year. 3 - Compute the present value (at the end of 1995) of each cash flow from 1996 to 2000. 4 - Compute the present value (at the end of 1995) of all the cash flows from 2001 to infinity. 5 - Put everything together to compute the value of the firm operations at the end of 1995. NOP Projection Sales - COGS = Gross Profit - Operating expenses = EBIT - Tax on EBIT = NOP (Net Operating Profit) 1,995 1,996 5,500 4,125 1,375 1,122 253 89 164 1,997 6,600 4,884 1,716 1,320 396 139 257 1,998 7,590 5,617 1,973 1,518 455 159 296 1,999 8,349 6,178 2,171 1,670 501 175 326 NFA Projection NFA NFA Projection 1,995 388 1,996 440 52 1,997 528 88 1,998 607 79 1,999 668 61 OWC Projection Accounts Receivable + Inventory - Accounts Payable - Accrued expenses OWC OWC Projection 1,995 606 587 376 75 742 1,996 654 671 115 80 1,130 388 1,997 785 795 137 96 1,346 216 1,998 902 914 157 111 1,549 203 1,999 993 1,005 172 122 1,705 156 Purchase Projection Beginning inventory + Purchases - COGS = Ending inventory 1,995 1,996 587 4,209 4,125 671 1,997 671 5,008 4,884 795 1,998 795 5,736 5,617 914 1,999 914 6,270 6,178 1,005 Free Cash Flow Projection & Discounting Net Operating Profit - Change in NFA 1,995 1,996 164 52 1,997 257 88 1,998 296 79 1,999 326 61 - - - - - Change in OWC - 388 - 216 Free Cash Flow Present Value at the end of 1995 - 275 247 - 47 38 - 203 14 10 - 156 109 70 Free Cash Flow % growth Free Cash Flow Residual value valued in 2000 We notice a constant growth pattern from 2001 onwards. Therefore we can appl This formula will give us the present value of all cash flows at the end of the year preced Putting it all together PV (FCF 96 to 00) + PV (FCF 01 to infinity) = Value of operations Value - 75 2,092 2,017 om large, nationally-recognized ould be interested if an guidance. ating assets at the end of 1995 on purchases for paying within by 2000. Margins and d the discount rate is 11.5%. 2000 2001 2002 2003 5% 74.0% 20.0% 6.0% 35% 5% 74.0% 20.0% 6.0% 35% 5% 74.0% 20.0% 6.0% 35% 5% 74.0% 20.0% 6.0% 35% 43.4 59.4 12.5 10 1.46% 43.4 59.4 12.5 10 1.46% 43.4 59.4 12.5 10 1.46% 43.4 59.4 12.5 10 1.46% nstant growth pattern year on year. - 2,000 8,766 6,487 2,279 1,753 526 184 342 2,001 9,205 6,812 2,393 1,841 552 193 359 2,002 9,665 7,152 2,513 1,933 580 203 377 2,003 10,148 7,510 2,639 2,030 609 213 396 2,000 701 33 2,001 736 35 2,002 773 37 2,003 812 39 2,000 1,042 1,056 179 128 1,791 86 2,001 1,094 1,109 188 134 1,881 90 2,002 1,149 1,164 197 141 1,975 94 2,003 1,207 1,222 207 148 2,073 99 2,000 1,005 6,537 6,487 1,056 2,001 1,056 6,864 6,812 1,109 2,002 1,109 7,208 7,152 1,164 2,003 1,164 7,568 7,510 1,222 2,000 342 33 2,001 359 35 2,002 377 37 2,003 396 39 - - - - 86 - 90 - 94 - 99 222 129 234 246 5.00% 258 5.00% 3606 2001 onwards. Therefore we can apply the growing perpetuity formula. h flows at the end of the year preceding the first cash flow, i.e. the end of 2000. CLARKSON LUMBER - Assignment 2 Following what was done in assignment 1 and going back to Clarkson Lumber balance sheet: 1 - Identify and value the non-operating assets of the firm as of 1995 2 - List and value the debt items of the firm as of 1995 3 - What is Mr. Clarkson' equity interest worth