Income Statements (thousand dollars) 2010E 2012E 2007-12-31 2008E 2007 2005-12-31 2006-12-31 2009E 2011E 2005 2006 Average 20.6% Growth rate 65.7% as % of sales Sales n/a 1,824,947 2,163,574 2,655,282 18.6% 22.7% Cost of sales 1214,242 1,419,973 1,724,969 66.5% 65.6% 65.0% Gross profit 743,601 610,705 930,313 14.4% as % of sales 4.4%as% of fixed assets 15.1% 13.6% Operating expenses 275,712 315,455 361,821 14.6% 59.497 275,496 4.4% 67.132 88,106 n/a Depreciation 4.5% 480,386 EBIT 361,014 Interest expense 21,171 12,790 16,234 Earnings before tax 254,325 348,224 464,152 26.1 % 24.9% Tax expense as % of taxable income 60,868 85,837 120,927 23.9% 24.6% Net income 193,457 262,387 343,225 40,0% as % of net income Dividends 137,290 77,383 104,955 40.0% 40.0% 40.0% Increase in retained earnings 116,074 157,432 205,935 Balance Sheets (thousand dollars) 2010E 2009E 2005-12-31 2006-12-31 2007-12-31 2008E 2011E 2012E 2005 2006 2007 Average 6.1% 53.0% 26.8% 2.5% Cash 125,079 118,994 153,810 6.5% 7.1% 4.7% Accounts receivable 59.4% 45.7% as % of sales 1,083,974 988,024 1,432,852 54.0% 722,044 as% of sales Inventories 428,762 639,688 23.5% 29.6% 27.2% 15% Other current assets as % of sales 26,975 46,341 105,601 2.1% 4.0% Total current assets 2,385,576 1,658,705 1,827,863 93.1 % 98.4 %| as% of sales 29.7% as % of sales Net fixed assets 1,487,470 2,015,352 3,199,243 81.5% 120.5% Other assets (operating) 26.8% 38.6% 430,778 579,121 1,025,317 23.6% Total assets 3,576,953 4,422,336 6,610,136 Current portion of long-term debt 10,582 20,854 21,056 21.1% 42.8% as% of sales Accounts payable 433,359 519,095 434,375 23.8% 20.0% 19.5% Other current liabilities as% of sales 805,800 847,549 1,198,548 44.2% 39.2% 45.1% Total current liabilities 1,250,757 1.301,762 1,738,699 Long-term debt 1,501,343 145,788 456,415 Common stock 1,051,319 725,000 1,551,319 Retained earnings 1,455,408 1,612,840 1,818,775 Total liabs. & equity 3,576,953 4,422,336 6,610,136 Trial assets Trial liabs. & equity = External fund needed Background: On 3 September 2008, the Coca-Cola Company offered to buy China Huiyuan Juice Group, the nation's largest juice maker (which was listed on Hong Kong Stock Exchange), for HKD17.92 billion in cash The acquisition was halted by the Chinese regulator; on 18 March 2009, China's Ministry of Commerce (MOC) announced that Coca-Cola's bid to acquire Huiyuan failed to meet the country's anti-monopoly law. Huiyuan's stock price gained 149 percent after Coca-Cola's announcement, which then quickly disappeared upon MOC's disapproval Questions: In early 2008, in preparation for negotiation with Coca-Cola for a possible deal, the chief financial officer (CFO) of Huiyuan, Mr. Francis Ng, worked to evaluate the fair value of his company. He started with forecasting. Suppose you were a member of the financial team led by Mr. Ng and worked on the five-year forecast of the financial statements for the period of 2008-2012. The firm's balance sheets and income statements of the years 2005-2007 are given. Corporate income was expected to be taxed at the marginal tax rate of 25%. 1. Huiyuan's sales growth during the forecast years was expected to maintain the historical average for the first two years, and then slow down to 18%, 149% and 10 %, respectively, for the remaining years. Complete the forecast table using historical average ratios wherever applicable. Forecast depreciation as a percentage of the prior year's net fixed assets. Huiyuan planned to increase its long-term debt by 20% each year, by issuing corporate bonds, throughout the forecast period. Each year's current portion was about 4.5% of the previous year's long-term debt. The company planned to maintain its dividend payout policy, raise no equity, and use either overdrafts (new short-term borrowings) or excess cash as the funding plug to balance the balance sheet. The interest rate was 7.5% on Huiyuan's long-term debt, 2.5% on excess cash (as deposit), and 13.0% on overdrafts (including bank fees). Interest expenses are determined based on the previous year's amounts of debt, involving no circularity problem. (4 points) 2. Suppose that Huiyuan's operating net working capital as a whole would change in proportion to sales, following its average percentage of sales over the period of 2005-2007. Compute Huiyuan's free cash flow and its components for each of the forecast years. If Huiyuan was expected to be valued at $15 billion at the end of 2012 and the adequate discount rate for Huiyuan's cash flow was 12%, what was the company's fair value? Compare this value with the acquisition offer price by Coca-Cola and, in no more than 50 words, explain the difference. (2.5 points) 3. By assessing Huiyuan's financing strategy, discuss whether the forecast is reasonable. Due to an increasing concern over the worsening economic conditions in 2008, Huiyuan ruled out the possibility of raising new equity in the future years. The juice industry had shown the following average ratios: return on invested capital of 7.5%, interest coverage (EBIT/Interest) of 3.7, and debt-to-value ratio (based on the book values) of 40%. You can use a table to summarize necessary key ratios to support your discussion. Your discussion should be no more than 200 words. (3.5 points) Income Statements (thousand dollars) 2010E 2012E 2007-12-31 2008E 2007 2005-12-31 2006-12-31 2009E 2011E 2005 2006 Average 20.6% Growth rate 65.7% as % of sales Sales n/a 1,824,947 2,163,574 2,655,282 18.6% 22.7% Cost of sales 1214,242 1,419,973 1,724,969 66.5% 65.6% 65.0% Gross profit 743,601 610,705 930,313 14.4% as % of sales 4.4%as% of fixed assets 15.1% 13.6% Operating expenses 275,712 315,455 361,821 14.6% 59.497 275,496 4.4% 67.132 88,106 n/a Depreciation 4.5% 480,386 EBIT 361,014 Interest expense 21,171 12,790 16,234 Earnings before tax 254,325 348,224 464,152 26.1 % 24.9% Tax expense as % of taxable income 60,868 85,837 120,927 23.9% 24.6% Net income 193,457 262,387 343,225 40,0% as % of net income Dividends 137,290 77,383 104,955 40.0% 40.0% 40.0% Increase in retained earnings 116,074 157,432 205,935 Balance Sheets (thousand dollars) 2010E 2009E 2005-12-31 2006-12-31 2007-12-31 2008E 2011E 2012E 2005 2006 2007 Average 6.1% 53.0% 26.8% 2.5% Cash 125,079 118,994 153,810 6.5% 7.1% 4.7% Accounts receivable 59.4% 45.7% as % of sales 1,083,974 988,024 1,432,852 54.0% 722,044 as% of sales Inventories 428,762 639,688 23.5% 29.6% 27.2% 15% Other current assets as % of sales 26,975 46,341 105,601 2.1% 4.0% Total current assets 2,385,576 1,658,705 1,827,863 93.1 % 98.4 %| as% of sales 29.7% as % of sales Net fixed assets 1,487,470 2,015,352 3,199,243 81.5% 120.5% Other assets (operating) 26.8% 38.6% 430,778 579,121 1,025,317 23.6% Total assets 3,576,953 4,422,336 6,610,136 Current portion of long-term debt 10,582 20,854 21,056 21.1% 42.8% as% of sales Accounts payable 433,359 519,095 434,375 23.8% 20.0% 19.5% Other current liabilities as% of sales 805,800 847,549 1,198,548 44.2% 39.2% 45.1% Total current liabilities 1,250,757 1.301,762 1,738,699 Long-term debt 1,501,343 145,788 456,415 Common stock 1,051,319 725,000 1,551,319 Retained earnings 1,455,408 1,612,840 1,818,775 Total liabs. & equity 3,576,953 4,422,336 6,610,136 Trial assets Trial liabs. & equity = External fund needed Background: On 3 September 2008, the Coca-Cola Company offered to buy China Huiyuan Juice Group, the nation's largest juice maker (which was listed on Hong Kong Stock Exchange), for HKD17.92 billion in cash The acquisition was halted by the Chinese regulator; on 18 March 2009, China's Ministry of Commerce (MOC) announced that Coca-Cola's bid to acquire Huiyuan failed to meet the country's anti-monopoly law. Huiyuan's stock price gained 149 percent after Coca-Cola's announcement, which then quickly disappeared upon MOC's disapproval Questions: In early 2008, in preparation for negotiation with Coca-Cola for a possible deal, the chief financial officer (CFO) of Huiyuan, Mr. Francis Ng, worked to evaluate the fair value of his company. He started with forecasting. Suppose you were a member of the financial team led by Mr. Ng and worked on the five-year forecast of the financial statements for the period of 2008-2012. The firm's balance sheets and income statements of the years 2005-2007 are given. Corporate income was expected to be taxed at the marginal tax rate of 25%. 1. Huiyuan's sales growth during the forecast years was expected to maintain the historical average for the first two years, and then slow down to 18%, 149% and 10 %, respectively, for the remaining years. Complete the forecast table using historical average ratios wherever applicable. Forecast depreciation as a percentage of the prior year's net fixed assets. Huiyuan planned to increase its long-term debt by 20% each year, by issuing corporate bonds, throughout the forecast period. Each year's current portion was about 4.5% of the previous year's long-term debt. The company planned to maintain its dividend payout policy, raise no equity, and use either overdrafts (new short-term borrowings) or excess cash as the funding plug to balance the balance sheet. The interest rate was 7.5% on Huiyuan's long-term debt, 2.5% on excess cash (as deposit), and 13.0% on overdrafts (including bank fees). Interest expenses are determined based on the previous year's amounts of debt, involving no circularity problem. (4 points) 2. Suppose that Huiyuan's operating net working capital as a whole would change in proportion to sales, following its average percentage of sales over the period of 2005-2007. Compute Huiyuan's free cash flow and its components for each of the forecast years. If Huiyuan was expected to be valued at $15 billion at the end of 2012 and the adequate discount rate for Huiyuan's cash flow was 12%, what was the company's fair value? Compare this value with the acquisition offer price by Coca-Cola and, in no more than 50 words, explain the difference. (2.5 points) 3. By assessing Huiyuan's financing strategy, discuss whether the forecast is reasonable. Due to an increasing concern over the worsening economic conditions in 2008, Huiyuan ruled out the possibility of raising new equity in the future years. The juice industry had shown the following average ratios: return on invested capital of 7.5%, interest coverage (EBIT/Interest) of 3.7, and debt-to-value ratio (based on the book values) of 40%. You can use a table to summarize necessary key ratios to support your discussion. Your discussion should be no more than 200 words. (3.5 points)