Mini Case

Your employer, a midsized human resources management company, is considering expansion into related fields, including the acquisition of Temp Force Company, an employment agency that supplies word processor operators and computer programmers to businesses with temporarily heavy workloads. Your employer is also considering the purchase of Biggerstaff & McDonald (B&M), a privately held company owned by two friends, each with 5 million shares of stock. B&M currently has free cash flow of $24 million, which is expected to grow at a constant rate of 5%. B&Ms financial statements report short-term investments of $100 million, debt of $200 million, and preferred stock of $50 million. B&Ms weighted average cost of capital (WACC) is 11%. Answer the following questions:

1. Your employer also is considering the acquisition of Hatfield Medical Supplies. You have gathered the following data regarding Hatfield, with all dollars reported in millions: (1) most recent sales of $2,000; (2) most recent total net operating capital, OpCap = $1,120; (3) most recent operating profitability ratio, OP = NOPAT/Sales = 4.5%; and (4) most recent capital requirement ratio, CR = OpCap/Sales = 56%. You estimate that the growth rate in sales from Year 0 to Year 1 will be 10%, from Year 1 to Year 2 will be 8%, from Year 2 to Year 3 will be 5%, and from Year 3 to Year 4 will be 5%. You also estimate that the long-term growth rate beyond Year 4 will be 5%. Assume the operating profitability and capital requirement ratios will not change. Use this information to forecast Hatfields sales, net operating profit after taxes (NOPAT), OpCap, free cash flow, and return on invested capital (ROIC) for Years 1 through 4. Also estimate the annual growth in free cash flow for Years 2 through 4. The weighted average cost of capital (WACC) is 9%. How does the ROIC in Year 4 compare with the WACC?

2.What is the horizon value at Year 4? What is the total net operating capital at Year 4? Which is larger, and what can explain the difference? What is the value of operations at Year 0? How does the Year-0 value of operations compare with the Year-0 total net operating capital?

3.What are value drivers? What happens to the ROIC and current value of operations if expected growth increases by 1 percentage point relative to the original growth rates (including the long-term growth rate)? What can explain this? (Hint: Use Scenario Manager.)