You have been hired as a consultant by Trader Joe's, a private American chain of grocery stores headquartered ten miles north of Whittier. The CEO is currently considering a project that would see Trader Joe's add in-store bakeries in its California locations. He has asked you to provide him with a thorough analysis so that he can make the right investment decision. The management team has also been approached by a potential buyer. Your second task is to value the firm. Here are some facts: Over the last few years, Trader Joe's California stores have sold ten million bakery products annually. All analysis points to this volume remaining steady in the future. If the company were to have an in-house bakery, you estimate that the average cost per product would be $1.10. Trader Joe's will mark up these products by 15%. To add a bakery, Trader Joe's would have to shift things around in the store and to purchase bakery equipment for $15,080,000 which will last for a very long time but it would be depreciated to zero for tax purposes using a 10-year straight-line depreciation schedule. This project would be financed solely by equity. Trader Joe's currently pays tax at a rate of 32%. You have collected some information about capital market retums (see Exhibit 1). The CEO asks you to submit answers to following questions in a business memo format. He also wants to see the work behind your analysis -- you need to also provide an Excel spreadsheet that supports your conclusions in the memo. Part I. Investment Decision a. What is the cost of capital that Trader Joe's should use for this project? b. Should Trader Joe's undertake this project? Suppose that Trader Joe's balance sheet shows that it has a debt ratio of 0.30 and a credit rating of BB. a. What is Trader Joe's weighted average cost of capital (WACC)? (The information provided in Table 12.3 in the textbook may be helpful here.) Suppose that Trader Joe's free cash flows (FCF) are forecasted to be as follows: Year 2021 2022 2023 2024 2025 FCF ($ millions 1,291 1,355 1,378 1,506 1,510 Starting in 2026 the company expects FCFs to grow at 2% indefinitely. b. Estimate the Trader Joes' enterprise value in 2020. c. How sensitive is your estimate of Trader Joes' enterprise yalue with respect to the choice of the discount rate and growth rate? Conduct a sensitivity analysis. You have been hired as a consultant by Trader Joe's, a private American chain of grocery stores headquartered ten miles north of Whittier. The CEO is currently considering a project that would see Trader Joe's add in-store bakeries in its California locations. He has asked you to provide him with a thorough analysis so that he can make the right investment decision. The management team has also been approached by a potential buyer. Your second task is to value the firm. Here are some facts: Over the last few years, Trader Joe's California stores have sold ten million bakery products annually. All analysis points to this volume remaining steady in the future. If the company were to have an in-house bakery, you estimate that the average cost per product would be $1.10. Trader Joe's will mark up these products by 15%. To add a bakery, Trader Joe's would have to shift things around in the store and to purchase bakery equipment for $15,080,000 which will last for a very long time but it would be depreciated to zero for tax purposes using a 10-year straight-line depreciation schedule. This project would be financed solely by equity. Trader Joe's currently pays tax at a rate of 32%. You have collected some information about capital market retums (see Exhibit 1). The CEO asks you to submit answers to following questions in a business memo format. He also wants to see the work behind your analysis -- you need to also provide an Excel spreadsheet that supports your conclusions in the memo. Part I. Investment Decision a. What is the cost of capital that Trader Joe's should use for this project? b. Should Trader Joe's undertake this project? Suppose that Trader Joe's balance sheet shows that it has a debt ratio of 0.30 and a credit rating of BB. a. What is Trader Joe's weighted average cost of capital (WACC)? (The information provided in Table 12.3 in the textbook may be helpful here.) Suppose that Trader Joe's free cash flows (FCF) are forecasted to be as follows: Year 2021 2022 2023 2024 2025 FCF ($ millions 1,291 1,355 1,378 1,506 1,510 Starting in 2026 the company expects FCFs to grow at 2% indefinitely. b. Estimate the Trader Joes' enterprise value in 2020. c. How sensitive is your estimate of Trader Joes' enterprise yalue with respect to the choice of the discount rate and growth rate? Conduct a sensitivity analysis
