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发表于 2012-3-31 14:20
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Starshah Industries competes in a high-growth, emerging technology sector that is facing increasing competitive pressures. So far, the firm has been performing well, earning $4.55 per share in 2004. Investment requirements were high, with capital expenditures of $1.75 per share, depreciation expense of $1.05, and a net investment in working capital that year of $1.00 per share. However, despite Starshah’s high growth rate and impressive profitability, Starshah’s Chairman, Lorenzo di Stefano, has become concerned about the impact that a slowdown in expected growth may have on the firm’s valuation.Di Stefano asked Starshah’s Director of Strategic Planning, Keisha Simmons, to make a presentation to Starshah’s board at the end of 2004 about the future growth of the firm. The news was sobering. Simmons told the board members that Starshah could expect two more years of rapid growth, during which time earnings per share could be expected to rise 45% per year with 30% annual increases in capital spending and depreciation. During this high-growth period, Simmons estimates that the required return on equity for Starshah will be 25%. Starshah consistently maintains a target debt ratio of 0.25.
After the near-term spurt of high growth, however, she and her group expect Starshah to move eventually to a stable growth period. During the stable growth period, free cash flow to equity (FCFE) will rise only 5% per year and the annual return to shareholders will decline to 10%.The strategy group expects the transitional period between high-growth and mature growth to last five years. During that time, capital expenditures will rise only 8% per year, with depreciation rising 13% per year. The growth in earnings should drop by eight percentage points per year, hitting 5% in the fifth year. During this transition, the expected return to shareholders will be 15% per year.
Throughout the high-growth and transitional growth periods, Simmons expects Starshah to be able to limit increases in the investment in working capital to 20 cents per year. In her analysis, the investment in working capital will peak in 2010, declining a dime to $2.10 per share in 2011.After Simmons’ presentation, the board debated what to do about the incipient slowdown in Starshah’s growth. A majority of the board argued in favor of moving to offset this slowdown in organic growth through a new emphasis on growth by acquisition.
One potential target is TPX. TPX's current and expected FCFE: $425,000 in 2004, $500,000 in 2005, $600,000 the following year, and $700,000 in 2007. After that, Starshah expects FCFE at TPX to grow 3% per year indefinitely. Starshah would require a return on its equity investment of 20% per year in the high-growth stage and 12% per year in the stable growth stage.Di Stefano and Simmons had a somber meeting the day after the board presentation. But despite the bleak news about future years, di Stefano had convinced himself it was worth staying around through the high-growth and transitional periods. He pointed out to Simmons that, if Simmons’ projections were correct, the value of Starshah’s stock would be in excess of $450 per share by the time the company hit the stable-growth phase. Di Stefano was very pleased with what that implied for the value of his stock options.
Simmons had done the same calculations herself, but she also realized that if required rates of return in 2012 rose from the very modest 10% she used in her board projections to only 15%, that would cut the terminal value of Starshah’s stock in 2011 to only half the level di Stefano was counting on. She considered that valuation too small to make the wait worthwhile. Simmons said nothing to di Stefano, but planned to look for another job. Which of the following FCFE models is best suited to analyzing TPX? | B)
| Stable growth FCFE model. |
| C)
| Three-stage FCFE model. |
|
The two-stage FCFE model is most suited to analyzing TPX because we have specific forecasts for the first several years and then a stable growth pattern into the indefinite future. (Study Session 12, LOS 40.i)
The FCFE for Starshah at the end of the transition period in 2011 is closest to:
In order to calculate FCFE for Starshah in 2011, we need to construct a table of the components of cash flow for Starshah.We are given the 2004 values for net income, capital expenditures, depreciation, and change in working capital. We are also given growth rates for each of the three stages of Starshah’s growth: high-growth for two years followed by transitional growth for five years, culminating in stable growth for the following years. Using the original values and their related growth rates, plus the formula for FCFE (see below), we can construct the following table: | 2004 | 2005 | 2006 | 2007 | 2008 | 2009 | 2010 | 2011 | | EPS | 4.55 | 6.60 | 9.57 | 13.11 | 16.91 | 20.46 | 23.12 | 24.27 | | Capital expenditures | 1.75 | 2.28 | 2.96 | 3.19 | 3.45 | 3.73 | 4.02 | 4.35 | | Depreciation | 1.05 | 1.37 | 1.77 | 2.01 | 2.27 | 2.56 | 2.89 | 3.27 | | Change in working capital | 1.00 | 1.20 | 1.40 | 1.60 | 1.80 | 2.00 | 2.20 | 2.10 | | FCFE | 3.28 | 5.02 | 7.63 | 11.01 | 14.67 | 18.08 | 20.62 | 21.89 |
FCFE = Earnings per share − (Capital Expenditures − Depreciation) × (1 − Debt Ratio) − (Change in working capital × (1 − Debt Ratio)) = 24.27 − (4.35 − 3.27) × (1 − 0.25) − (2.10 × (1 − 0.25))
= 24.27 − 0.81 − 1.57 = 21.89
FCFE = $21.89 per share in 2011.
(Study Session 12, LOS 40.j)
Regarding di Stefano’s and Simmons’ statements about the terminal value of Starshah stock in 2011: | B)
| only di Stefano is correct. |
| C)
| only Simmons is correct. |
|
Starshah hits the stable growth phase in 2012. At that point,
Terminal Firm Value2011 = (FCFE in year 2012) / (required rate of return − growth rate)
= $21.89 (1.05) / (0.10 − 0.05) = $22.98 per share / 0.05
= $460 per share. Di Stefano’s statement is correct.
Terminal Firm Value2011 = (FCFE in year 2012) / (required rate of return − growth rate) = $21.89 (1.05) / (0.15 − 0.05)
= $22.98 per share / 0.10 = $230 per share. Simmons’ statement is also correct.
(Study Session 12, LOS 40.j)
Assuming Simmons is right that the required return on Starshah equity rises to 15% in 2012 and beyond, what is the value of Starshah stock at the end of 2004?
In order to calculate the firm value, we need to know the discount rate that applies over each period. Since the discount rate changes, we can simplify the arithmetic by constructing a table of discount factors using 25% for each of the first two years and 15% for each of the following five years: | 2005 | 2006 | 2007 | 2008 | 2009 | 2010 | 2011 | | Discount factor | 1.25 | 1.56 | 1.80 | 2.07 | 2.38 | 2.73 | 3.14 |
We can then calculate firm value in 2004 using the FCFE values we calculated in question 1 and the stock value in the year 2012 (that we calculated in question 3).
Starshah equity value in 2004 = (5.02 / 1.25) + (7.63 / 1.56) + (11.01 / 1.80) + (14.67 / 2.07) + (18.08 / 2.38) + (20.62 / 2.73) + (21.89 / 3.14) + (230 / 3.14)= 4.02 + 4.89 + 6.12 + 7.09 + 7.60 + 7.55 + 6.97 + 73.25
= 117.49The value of Starshah stock at the end of 2004 is $117.49 per share. (Study Session 12, LOS 40.j)
What is the maximum amount that Starshah would be willing to pay for TPX (in millions)?
Firm Value = [500 / (1.20)1] + [600 / (1.20)2] + [700 / (1.20)3] + [(700)(1.03) / (0.12 − 0.03) / (1.20)3] = $5,874.The most that Starshah could pay for TPX and still meet its required return targets is $5.874 million. (Study Session 12, LOS 43.j)
Which of the following FCFE models is best suited to analyzing Starshah Industries? A)
| Three-stage FCFE model. |
| B)
| Stable growth FCFE model. |
| |
The three-stage FCFE model is most suited to analyze firms in high growth industries that will face increasing competitive pressures over time, since those competitive pressures will lead to a gradual decline in the firm’s growth rate (second stage) to a stable level (third stage). (Study Session 12, LOS 40.i) |
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