Mutual Fund Management Firm - Case Study Example

A conference was called by XYZ, Inc. where XYZ’s management disclosed the latest fiscal-year results to the financial analysts. XYZ Inc. is one of the leaders in the apparel/shoes industry with about 80% of its revenue generated from apparel, while the rest is coming from the shoe sector.  At the meeting, management revealed the strategy to revitalize its slowing operating performance.  The focus of this strategy is to expand its product offerings to foreign markets.  This is in part to create some of the natural hedge positions because management wanted to emphasize more efforts to control its expenses as XYZ faced a strong adverse effect of a weak dollar.  With these new strategies, management believed that they can achieve long-term revenue growth targets of 8-10% and earnings growth of about 15%. Analysts’ reports following the conference call by XYZ show the mixed reactions of analysts, ranging from “strong buy” recommendations to “hold” recommendations.  However, your boss believes that it is worth investigating if XYZ is undervalued.  To do so, she wants you to find the estimated WACC for XYZ, Inc.  This WACC will be used by your boss to find the intrinsic value of XYZ, Inc. Consolidated Balance Sheet (in $million)  

  2008 2009 Assets   Current assets:   Cash and equivalents 254.3 304 Accounts receivables 1569.4 1621.4 Inventories 1446 1424.1 Deferred income taxes 111.5 113.3 Prepaid expenses 215.2 162.5 Total current assets 3596.4 3625.3 Property, plant, and equipment, net 1583.4 1618.8 Identifiable intangible assets and goodwill, net 410.9 397.3 Deferred income taxes and other assets 265.9 177.9 Total assets 5856.6 5819.3 Liabilities and owners’ equity   Current liabilities   Current portion of long-term debt 50.1 5.4 Notes payable 924.2 855.3 Accounts payable 543.8 432 Accrued liabilities 621.9 472.1 Income tax payable - 21.9 Total current liabilities 2140 1786.7 Long-term debt 470.3 435.9 Deferred income taxes and other liabilities 110.3 102.2 Owners’ Equities:   Common stock, par (300 million shares outstanding) 2.8 2.8 Capital over stated value 369 459.4 Unearned stock compensation (11.7) (9.9)  Accumulated other comprehensive income (111.1) 152.1)  Retained earnings 2887 3194.3 Total owners’ equity 3136 3494.5 Total liabilities and owners’ equity 5856.6 5819.3   WACC Calculation  Cost of Equity The first step in the calculation of WACC is calculating the estimated cost of Equity. This is calculated by estimating different components of CAPM. The Capital Asset Pricing Model is mathematically calculated as follows: r=r_f+β(r_m-r_f) r= This is the rate of return that the investor gets on their investment in equity r_f= this is the risk-free rate prevalent in the market, the 12-month t-bill rate is the assumed risk-free rate β= beta of the security  r_m= the market rate of return  CAPM Risk-Free Rate Market Return Risk Premium Beta CAPM   2009 0.24% 7.74% 7.50% 1.16 8.94%   Using the CAPM formula the expected rate of return for the equity of the stock is calculated above. Cost of long term Debt  PV -920 FV 1000 Coupon 128.2 Rate 14.02% Period 21 That value according to available data is $920. The FV for all bonds is the standard $1000. The annual coupon on the bond is 12.8% which makes $128.2. Using this data the rate of return on the bond is 14.02%. Weights  The following components are outstanding debt and equity:   Book Value   Current portion of long-term debt 5.4 Notes payable 855.3 Accounts payable 432 Accrued liabilities 472.1 Long-term debt 435.9 Common stock, par (300 million shares outstanding) 2.8 Capital over stated value 459.4 Retained earnings 3194.3 Total 5857.2   Weights are assigned to each according to their proportion to total financing:   Weights   The current portion of long-term debt is 0.09% Notes payable 14.60% Accounts payable 7.38% Accrued liabilities 8.06% Long-term debt 7.44% Common stock, par (300 million shares outstanding) 0.05% Capital over stated value 7.84% Retained earnings 54.54% Total 100.00%   The cost has been assigned to each instrument as follows: Cost   The current portion of long-term debt is 4.25% Notes payable 1.34% Accounts payable 0.12% Accrued liabilities 0.12% Long-term debt 14.02% Common stock, par (300 million shares outstanding) 8.94% Capital over stated value 8.94% Retained earnings 8.94%   The weights of each instrument are multiplied by their respective percentage in total financing to calculate the WACC: Wacc   Current portion of long-term debt 0.00% Notes payable 0.20% Accounts payable 0.01% Accrued liabilities 0.01% Long-term debt 1.04% Common stock, par (300 million shares outstanding) 0.00% Capital over stated value 0.70% Retained earnings 4.88% 6.84%   The WACC is estimated at 6.84%.  Read More