Valuation of Polaris Industries Inc. Polaris Industries Inc. designs, manufactures, and markets motorized products for recreation and utility use. Its products consist of all-terrain recreational and utility vehicles (ATVs), snowmobiles, motorcycles, and related parts, garments, and accessories. Polaris products are sold through a network of nearly 1,700 dealers in North America, five subsidiaries, and 40 distributors in 126 countries outside North America. This assignment puts you in the shoes of financial analyst advising a portfolio manager of an equity mutual fund. Your job is to estimate a fair price for Polaris as of December 31, 2005 using the historical statements and the assumptions provided below. Answer the questions that follow to guide you through the forecast and valuation. Assumptions Valuation Model Assumptions Forecast the financial statements (and free cash flow) for 2006 and then assume that free cash flow grows at a constant rate in perpetuity. Assume that all cash flows occur at year-end, so the 2006 cash flows will occur in one year. . Assume long-term growth rate of 2.5%. Financial Statements Forecast Assumptions Sales in 2006 will be 2.5% larger than 2005. Estimate the depreciation rate and the ratio of growth CAPEX to the change in sales (gCAPEX/ASales) using the 2005 financial data. Assume that the investment in net working capital (for the free cash flow calculation) is 7.5% of the increase in sales. So if sales in 2006 are $1 more than capital is $0.075. Assume that the following accounts remain unchanged in 2006: Goodwill & Intangibles, Other Current Liabilities, Long-Term Debt, and Common Stock. The loss from discontinued operations is $0 in 2006. Cash is the plug account. No dividends are paid in 2006. Use 2005 ratios for all percent-of-sales forecasts. Tax rate= 33% 2005, then the investment in net working WACC Assumptions Interest cost on debt = 4.6%. The risk-free rate, kf, is 3.75%. The market risk premium, E(KM) - Kf = 7%. Polaris's beta is 1.18. Polaris's capital structure weights are wp = 1% and WE = 99%. Assume that these weights are optimal and that Polaris will maintain them in perpetuity. Revenue Cost of Goods Sold SG&A, R&D Depreciation EBIT Interest Expense Earnings Before Taxes Provision for Income Taxes Net Income (Continuing Operations) Loss from Discontinued Operations Net Income Shares Outstanding Current Assets Cash Accounts Receivable Total Current Assets Net Property and Equipment Goodwill & Intangibles Total Assets LIABILITIES & OWNERS' EQUITY Current Liabilities Accounts Payable Other Total Current Liabilities Long-Term Debt Polaris Industries Inc. Income Statement and Balance Sheet As of December 31 ($000's) 2004 Total Liabilities Owners' Equity Common Stock Retained Earnings Total Owners' Equity Total Liabilities & Owners' Equity 1,799,914 1,348,943 209,514 35,147 206,310 2,111 204,199 67,386 136,813 -32,309 104,504 2004 138,469 327,186 465,655 200,901 126,369 792,925 405,193 8,000 413,193 18,000 431,193 427 361,305 361,732 792,925 2005 Ratios 2006 1,907,019 0.0250 1,954,694 1,451,927 213,114 28,632 213,346 4,713 0.0460 208,633 64,348 0.330 144,285 -1,007 143,278 42,131 2005 19,675 354,313 373,988 222,336 172,632 768,956 375,614 5,685 381,299 18,000 399,299 417 369,240 369,657 768,956 Ratios 0 2006 172,632 5,685 18,000 417 Part 1 What is the ratio of growth CAPEX to the change in sales (gx) in 2005? (Hint: First calculate the depreciation rate, maintenance CAPEX, and total CAPEX.) Express your answer in percentage form rounded to one decimal place. gx ratio= What is the depreciation expense in 2006? (Hint: First calculate maintenance CAPEX, growth CAPEX, and total CAPEX.) Express your answer in thousands of dollars rounded to one decimal place. Depreciation expense = $ Part 3 What is free cash flow in 2006? Express your answer in thousands of dollars rounded to one decimal place. Free cash flow - S Part 4 What is Polaris' WACC? Express your answer in percentage form rounded to one decimal place. WACC = % Part 5 What is the fair price for a share of Polaris? Express your answer in dollars rounded to two decimal places. Don't use rounded values in your calculations. Carry many significant figures. For maximum accuracy, use a spreadsheet. Fair price = $ Check Answer Check Answer Check Answer Check Answer Check Answer Valuation of Polaris Industries Inc. Polaris Industries Inc. designs, manufactures, and markets motorized products for recreation and utility use. Its products consist of all-terrain recreational and utility vehicles (ATVs), snowmobiles, motorcycles, and related parts, garments, and accessories. Polaris products are sold through a network of nearly 1,700 dealers in North America, five subsidiaries, and 40 distributors in 126 countries outside North America. This assignment puts you in the shoes of financial analyst advising a portfolio manager of an equity mutual fund. Your job is to estimate a fair price for Polaris as of December 31, 2005 using the historical statements and the assumptions provided below. Answer the questions that follow to guide you through the forecast and valuation. Assumptions Valuation Model Assumptions Forecast the financial statements (and free cash flow) for 2006 and then assume that free cash flow grows at a constant rate in perpetuity. Assume that all cash flows occur at year-end, so the 2006 cash flows will occur in one year. . Assume long-term growth rate of 2.5%. Financial Statements Forecast Assumptions Sales in 2006 will be 2.5% larger than 2005. Estimate the depreciation rate and the ratio of growth CAPEX to the change in sales (gCAPEX/ASales) using the 2005 financial data. Assume that the investment in net working capital (for the free cash flow calculation) is 7.5% of the increase in sales. So if sales in 2006 are $1 more than capital is $0.075. Assume that the following accounts remain unchanged in 2006: Goodwill & Intangibles, Other Current Liabilities, Long-Term Debt, and Common Stock. The loss from discontinued operations is $0 in 2006. Cash is the plug account. No dividends are paid in 2006. Use 2005 ratios for all percent-of-sales forecasts. Tax rate= 33% 2005, then the investment in net working WACC Assumptions Interest cost on debt = 4.6%. The risk-free rate, kf, is 3.75%. The market risk premium, E(KM) - Kf = 7%. Polaris's beta is 1.18. Polaris's capital structure weights are wp = 1% and WE = 99%. Assume that these weights are optimal and that Polaris will maintain them in perpetuity. Revenue Cost of Goods Sold SG&A, R&D Depreciation EBIT Interest Expense Earnings Before Taxes Provision for Income Taxes Net Income (Continuing Operations) Loss from Discontinued Operations Net Income Shares Outstanding Current Assets Cash Accounts Receivable Total Current Assets Net Property and Equipment Goodwill & Intangibles Total Assets LIABILITIES & OWNERS' EQUITY Current Liabilities Accounts Payable Other Total Current Liabilities Long-Term Debt Polaris Industries Inc. Income Statement and Balance Sheet As of December 31 ($000's) 2004 Total Liabilities Owners' Equity Common Stock Retained Earnings Total Owners' Equity Total Liabilities & Owners' Equity 1,799,914 1,348,943 209,514 35,147 206,310 2,111 204,199 67,386 136,813 -32,309 104,504 2004 138,469 327,186 465,655 200,901 126,369 792,925 405,193 8,000 413,193 18,000 431,193 427 361,305 361,732 792,925 2005 Ratios 2006 1,907,019 0.0250 1,954,694 1,451,927 213,114 28,632 213,346 4,713 0.0460 208,633 64,348 0.330 144,285 -1,007 143,278 42,131 2005 19,675 354,313 373,988 222,336 172,632 768,956 375,614 5,685 381,299 18,000 399,299 417 369,240 369,657 768,956 Ratios 0 2006 172,632 5,685 18,000 417 Part 1 What is the ratio of growth CAPEX to the change in sales (gx) in 2005? (Hint: First calculate the depreciation rate, maintenance CAPEX, and total CAPEX.) Express your answer in percentage form rounded to one decimal place. gx ratio= What is the depreciation expense in 2006? (Hint: First calculate maintenance CAPEX, growth CAPEX, and total CAPEX.) Express your answer in thousands of dollars rounded to one decimal place. Depreciation expense = $ Part 3 What is free cash flow in 2006? Express your answer in thousands of dollars rounded to one decimal place. Free cash flow - S Part 4 What is Polaris' WACC? Express your answer in percentage form rounded to one decimal place. WACC = % Part 5 What is the fair price for a share of Polaris? Express your answer in dollars rounded to two decimal places. Don't use rounded values in your calculations. Carry many significant figures. For maximum accuracy, use a spreadsheet. Fair price = $ Check Answer Check Answer Check Answer Check Answer Check