Question 7

You have been asked to value Speedy Sports, Inc., a publicly-traded sporting goods company. Using Speedy stock return data from the past five years you have estimated the companys equity beta to be 1.10. You also noted that during the past five years Speedy had an average long-term debt/total capital ratio of 20% and excess cash (cash in excess of that necessary for operations) equal to an average of 15% of the total market value of the company.

Today, the market value of Speedys equity (stock price number of outstanding shares) is $3,400 million and the company has $500 million of excess cash. Speedys debt is currently yielding 4.5%, the risk-free rate is 2.98%, and the market risk premium is 5.63%. Going forward, you believe that Speedys operating assets will support a target leverage ratio of 1/3 long-term debt and 2/3 equity. You can assume that the risk of Speedys debt today is reflective of its risk over the past five years and into the future.

During the last 12 months, Speedy had EBIT of $450 million and the firm paid income taxes equal to 40% of its pre-tax income. The $450 million includes interest income of $20 million that the company earned on its current cash holdings.

Assume that Speedy is a mature firm that is expected to grow at a constant rate of 5% per year in the future. Also assume that capital expenditures and additions to working capital, net of depreciation, are expected to total $90 million next year.

A) What is the WACC for Speedys operating assets (excluding excess cash)?

B) Assume that Speedy currently has $1,700 million of long-term debt outstanding. What are the intrinsic values of the non-cash (operating) assets of the company, the total firm, and the firms outstanding equity?