1. Santa’s Shoes is a retailer that has just begun having financial difficulty. Santa’s suppliers are aware of the increased possibility of bankruptcy. What might Santa’s suppliers do based
2. A few years ago, a friend of yours started a small business that develops gaming software. The company is doing well and is valued at $1.5 million based on multiples for comparable public companies after adjustments for their lack of marketability. With 300,000 shares outstanding, each share is estimated to be worth $5. Your friend, who has been serving as CEO and CTO (chief technology officer), has decided that he lacks sufficient managerial skills to continue to build the company. He wants to sell his 160,000 shares and invest the money in an MBA education. You believe you have the appropriate managerial skills to run the company. Would you pay $5 each for these shares? What are some of the factors you should consider in making this decision?
3. A friend of yours is trying to value the equity of a company and, knowing that you have read this book, has asked for your help. So far she has tried to use the FCFE approach. She estimated the cash flows to equity to be as follows:
| Sales | $800.0 |
| -CGS | -450.0 |
| -Depreciation | -80.0 |
| -Interest | -24.0 |
| Earnings before taxes (EBT) | 246.0 |
| -Taxes (0.35 x EBT) | -86.1 |
| = Cash Flow to Equity | $159.9 |
She also computed the cost of equity using CAPM as follows:
k
E = k
F + β
E(Risk premium) = 0.06 + (1.25 x 0.084) = 0.165, or 16.5%
where the beta is estimated for a comparable publicly traded company. Using this cost of equity, she estimates the discount rate as
WACC = x
Debt
k
Debt
pretax(1 –
t) +
xcskcs
= [0.20 x 0.06 x (1-0.35)]+(0.80 x 0.165) = 0.14, or 14%
Based on this analysis, she concludes that the value of equity is $159.9 million/0.14 = $1,142 million.
Assuming that the numbers used in this analysis are all correct, what advice would you give your friend regarding her analysis?
