Conduct your valuation at December 31 2005. Take all data as referring to values at the end of each
calendar year. Your goal is to estimate and value the FCFs that start in 2006 and onwards. Buckeye
Computer, Inc. (BCI) is introducing a new line of image generators and visual workstations in 2006. BCI’s
revenues should grow by 13% per year through 2010. The line should yield operating profit margins of
20%.1 Because of rapid technological change in the industry, the product life cycle of the workstations is
no more than 5 years. As a result, at the beginning of 2011, BCI will introduce a second generation of
workstations with fully-integrated image generators based on research already under way. The second
line is predicted, on average, to yield growth in revenue of 8% and operating profit margins of 12%
starting in 2011 and lasting into the indefinite future [To be clear: Sales growth from 2010 to 2011 is 8%
and this growth rate will be maintained from then on]. Other forecast ratios for BCI are given in Exhibit 2.
BCI’s past financial statements are given in Exhibit 1. The current rate of interest on risk free 30-day
treasury bills is 4.8%. The yield on 10-year treasury bonds is 5.8%. Other companies that produce similar
high performance image generators and visual workstations have on average equity betas of 0.9523.
These firms have no net debt. Buckeye itself has an equity beta of 1.20. You will be evaluating the
purchase of Buckeye Computer whose equity currently (end of 2005) has a market value of
approximately $2,900 million (50 million shares at $58 each).
- What are the expected free cash flows for Buckeye for each year from 2006 through 2010?
- Careful analysis of Buckeye’s strategy, its markets and its dependence on outside sources of funding,
software writers, customers, etc., suggests prudent worst case interest coverage (i.e., coverage that
would not significantly impair operations) for Buckeye is 3. It is estimated that Buckeye will be able to
borrow at a long-term interest rate of about 8.0% per year. Using this information, estimate the optimal
capital structure (i.e. net debt to enterprise value ratio at market values) for BCI. - Estimate the equity beta for Buckeye post-purchase (i.e. at the optimal capital structure). Use this to
estimate what BCI’s opportunity cost of equity capital will be. Finally, use this to estimate Buckeye’s
weighted average cost of capital, i.e., the discount rate for evaluating the purchase? Explain your
calculations. As usual, use 5% for the market risk premium. - Estimate the expected residual value at the end of 2010 for Buckeye as a growing perpetuity.
- What is your valuation of Buckeye Computers and the value per share of its equity?
2001 2002 2003 2004 2005
Sales 1,604 1,950 2,240 2,456 3,017
Cost of Goods Sold 842 1,020 1,226 1,517 1,739
R&D Expense 158 203 240 278 327
SG&A Expense 367 446 479 522 549
Operating Income (EBIT) 237 281 295 139 402
Interest Expense 8 6 5 13 14
Earnings before Tax 229 275 290 126 388
Income Taxes 85 108 107 40 141
Earnings (NI) 144 167 183 86 247
Dividends 0 18 28 45 49
to Retained Earnings 144 149 155 41 198
2001 2002 2003 2004 2005
Cash 103 58 45 17 30
Accounts Receivable 219 283 328 349 431
Inventory 282 348 420 500 584
Prepaid Expenses 18 22 24 28 32
Current Assets 622 711 817 894 1,077
Plant, Property & Equipment (net) 442 521 581 659 747
Total Assets 1,064 1,232 1,398 1,553 1,824
Accounts Payable 145 177 203 233 285
Accrued Expenses 30 32 34 18 31
Short-Term Debt 41 31 19 124 35
Current Liabilities 216 240 256 375 351
Long-Term Debt 55 50 45 40 137
Net Worth 793 942 1,097 1,138 1,336
Liabilities & Net Worth 1,064 1,232 1,398 1,553 1,824
Ratio
Projected
Level
Accounts Receivable/Sales 15%
Inventory/Sales 20%
Prepaid Expenses/Sales 2%
Accounts Payable/Sales 9%
Accrued Expenses/Sales 1%
Net Operating Working Capital/Sales 27%
Net PP&E/Sales 25%
Tax Rate 35%