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C&C is a 5-year old chain of 12 medium-sized supermarkets. The supermarkets are targeting the middle- and top-income segments. The supermarkets are located in suburban areas and mainly focus on healthy, green, high-quality products.
Supplementary notes for Stage II
· For the period 2013-2017, the relevant CoC is estimated at 12%.
· The P/E ratio decreases to 9,0 in 2013 , but is assumed to increase, subsequently, by 0,5 per annum.
Draw-up CC's pro forma balance sheet and income statement for the period 2013-2017, which are a function of the 2012 statements and the following assumptions (Note: use the prepared template in "Basic Data II"):
· An increase in sales volumes and lower sales prices together result in sales increasing by 5% per annum.
· Cost of goods sold are 75% of sales.
· Salaries & wages, General expenses and Electricity, water, insurance can be grouped together and modelled according to the "Percent of sales method" (based on 2012).
· Annual depreciation in a particular year is based on the gross fixed assets of the previous (!) year and an average asset life of 30 years.
· Investment income is based on a return of 3% per annum on the item Cash & Short-term savings account of the previous (!) year.
· Interest expense is a function of an average interest rate of 10% on all long-term debt instruments of the previous (!) year's amounts. However, if the previous year's long-term debt were to fall below €2M, the interest rate will decrease to 8%.
Tip: Excel has a very elegant conditional formula "WENN(...;...;...)" Check it out ;-)
· Taxes can be determined using an average tax rate of 27,5% on earnings before tax.
· Common stock dividends are only paid if earnings after tax are positive. In such a case, the dividend pay-out rate is 40%.
· CC's asset side is, essentially, the driver of its finance structure.
· Gross fixed assets are expected to grow by 6% per annum.
· Accumulated depreciation changes by the amount of annual depreciation (income statement).
· Cash & Short-term savings account increases from €111,000 to €145,000 in 2013. Thereafter it grows by 5% per annum.
· Accounts receivables and inventories can be both modelled according to the "Percent of sales method" (based on 2012). Prepaid rentals will remain constant at €40,000.
· Common stock capital will remain the same as in 2012 (no further right issues).
· Retained earnings, are (obviously) a direct function of retained earnings for the year (see income statement).
· The total of current liabilities (grouped together) will be 8% of sales.
· Finally, you should regard long-term debt as "the plug". That is, any capital shortage will be financed by means of extra long-term debt, whereas a capital surplus will lead to a redemption of (the corresponding portion) of long-term debt.
Determine the financial ratios that are part of the "Basic Data II" worksheet for 2013-2017. Calculate also the averages for the pro-forma period.
Determine C&C's (a) Bankers' cash flow and (b) Free cash flow (FCF). With regard to the FCF, the annual investment in fixed assets reflects the annual change in the item "Gross fixed assets".
List the key findings of CC's pro forma performance, with reference to the financial ratios (Q10) and the cash flow (Q11).
CC is interested in the DCF technique, more particularly in an analysis of the period 2013-2017. The CEO is of the opinion that the following simplifying assumptions can be made:
- The initial investment represents total assets at the beginning of the period under consideration (1.1.2013). The amount of total assets at 31.12.2012 can be assumed to equal those on 1.1.2013.
- Cash flows reflect so-called "free cash flows".
- The terminal value represents total assets at the end of 2017. However, to estimate market values, the amount should be increased by a factor 1,20.
(14) Compare the results of the DCF analysis (Q.13) with the traditional profitability ratios (Q10).
In view of the return of 3% on Cash & Short-term savings, how can one justify the implicit re-investment return (COC in the case of the NPV method and IRR in case of the IRR method)?
(15) INFA_LYS Inc has conducted its own pro-forma analysis. Because of the (perceived) existence of opportunity costs (initial investment and terminal value) and the (perceived) need for a substantial additional investment in 2014, there are some notable differences between their estimations and those in Q.13. (See the worksheet "Basic Data II"). Their estimated CoC is 11%.
- Re-calculate the NPV
- Re-calculate the NPV, using a modified approach by adopting an explicit re-investment rate of 5% on all the positive operational CFs.
You can assume that the positive operational CFs will be re-invested till the end (2017).
- Re-calculate the NPV, using a modified approach by adopting an explicit re-financing rate of 8% on all the negative operational CFs. You can assume that the negative operational CFs will be re-deemed as soon as positive CFs will be available.
- Explain briefly why each of the two modified NPVs changed when compared with the initial INFA_LYS NPV.
Understanding CC's value based on your pro-forma estimates (Q.9 - 11). Use the following approaches to estimate CC's value at the end of 2017:
- the share price, using the appropriate P/E and EPS numbers;
- the book value per share;
- the zero growth model, using a required return of 11% and the appropriate EPS (rather than dividends per share);
- the constant growth model, using a required return of 11%, the growth rate in CF provided by operating activities (2012-2017), and the appropriate CF provided by operating activities number (rather than dividends per share).
-Discuss briefly how you would "adjust" these value estimates to get an idea of their equivalent value at 1.1.2013. (You are not expected to calculate these values: simply explain the method(s) and the relevant values.
The CFO realizes that the traditional financial statements do not properly reflect all CC's assets. He has followed the discussion on Baruch Lev's "residual method" and requires your help to estimate the value of CC's intangible assets for 2012, based on the following information and assumptions:
According to the accountant, the net fixed assets in 2012, calculated at book value, should be decreased by 10% to reflect estimated market values, which is apparently a better base for determining the "proxy return" on CC's physical assets. Such an adjustment is not required for the current assets.
CC's financial investment is represented by its current assets in 2012. However, the inventories reflect physical assets. Obviously, the net fixed assets also reflect physical assets.
The normalized annual return (for 2012) can be based on CC's earnings after tax, increased by 2%.
- Based on the above, use Lev's residual approach to estimate the value of CC's intangible assets
- Based on the above, determine and evaluate the "market to comprehensive value" ratio
Recall that in 2012 the market price of common stocks is €33.