Consider HES financial statements given below. Assume the Company's beta is estimated to be 1.5, risk free rate 2%, and market risk premium 10%. Furthermore, assume the company has a long-term growth rate for 2% after the fifth year and net income, and comprehensive income will be identical.
What is the company's value using the following methods:
a) Residual Income
b) Free Cash Flow to Equity
c) Free Cash Flows to the Company
d) Analyze and explain which one of the above valuation methods provides a better and more realistic valuation.
|
Income Statements
|
Year +1
|
Year +2
|
Year +3
|
Year +4
|
Year +5
|
|
Revenues
|
$1,976,000
|
$2,074,800
|
$2,178,540
|
$2,287,467
|
$2,401,840
|
|
Cost of Sales
|
1,213,659
|
1,274,342
|
1,338,059
|
1,404,962
|
1,475,210
|
|
Gross Profit
|
$762,341
|
$800,458
|
$840,481
|
$882,505
|
$926,630
|
|
Accounting
|
6,000
|
6,300
|
6,615
|
6,946
|
7,293
|
|
Advertising & Promotion
|
15,000
|
12,360
|
12,731
|
13,113
|
13,506
|
|
Bank Charges
|
41,496
|
43,571
|
45,749
|
48,037
|
50,439
|
|
Compensation & Benefits
|
246,643
|
254,042
|
261,663
|
269,513
|
277,598
|
|
Consulting Fees
|
2,400
|
0
|
0
|
0
|
0
|
|
Insurance
|
1,000
|
1,050
|
1,103
|
1,158
|
1,216
|
|
Lease - Facilities
|
336,000
|
336,000
|
336,000
|
336,000
|
336,000
|
|
Legal & Professional
|
500
|
500
|
500
|
500
|
500
|
|
Licenses & Fees
|
500
|
510
|
520
|
531
|
541
|
|
Maintenance
|
600
|
612
|
624
|
637
|
649
|
|
Miscellaneous
|
1,800
|
1,836
|
1,873
|
1,910
|
1,948
|
|
Office supplies
|
2,700
|
2,754
|
2,809
|
2,865
|
2,923
|
|
Security
|
720
|
742
|
764
|
787
|
810
|
|
Telephone
|
1,800
|
1,836
|
1,873
|
1,910
|
1,948
|
|
Utilities
|
4,200
|
4,410
|
4,631
|
4,862
|
5,105
|
|
Website
|
1,800
|
1,800
|
1,800
|
1,800
|
1,800
|
|
Total Operating Exp.
|
663,159
|
668,323
|
679,255
|
690,569
|
702,276
|
|
EBIDTA
|
$99,182
|
$132,135
|
$161,226
|
$191,936
|
$224,354
|
|
Depreciation
|
4,916
|
4,916
|
4,916
|
4,916
|
4,916
|
|
Operating Profit
|
$94,266
|
$127,219
|
$156,310
|
$187,020
|
$219,438
|
|
Interest Expense
|
43,199
|
40,274
|
37,059
|
33,524
|
29,639
|
|
Earnings Before Taxes
|
51,067
|
86,945
|
119,251
|
153,496
|
189,799
|
|
Income Taxes
|
17,873
|
30,431
|
41,738
|
53,724
|
66,429
|
|
Net Income
|
$33,194
|
$56,514
|
$77,513
|
$99,772
|
$123,370
|
|
Balance Sheets
|
Begin
|
Year +1
|
Year +2
|
Year +3
|
Year +4
|
Year +5
|
|
Cash
|
$33,150
|
$110,697
|
$210,697
|
$243,259
|
$293,834
|
$363,370
|
|
Inventory
|
425,000
|
425,000
|
424,781
|
446,020
|
468,321
|
491,737
|
|
Prepaid Leases
|
28,000
|
28,000
|
28,000
|
28,000
|
28,000
|
28,000
|
|
Total Current Assets
|
$486,150
|
$563,697
|
$663,478
|
$717,279
|
$790,155
|
$883,107
|
|
Fixed Assets
|
33,850
|
33,850
|
33,850
|
33,850
|
33,850
|
33,850
|
|
Less: Depreciation
|
0
|
4,916
|
9,832
|
14,747
|
19,664
|
24,579
|
|
Net Fixed Assets
|
33.85
|
28,934
|
24,018
|
19,103
|
14,186
|
9,271
|
|
Total Assets
|
$520,000
|
$592,631
|
$687,496
|
$736,382
|
$804,341
|
$892,378
|
|
Accounts Payable
|
0
|
68,908
|
139,654
|
146,637
|
153,968
|
161,667
|
|
Long Term Debt
|
468,000
|
438.529
|
406,133
|
370,522
|
331,377
|
288,346
|
|
Total Liabilities
|
468,000
|
507,437
|
545,787
|
517,159
|
485,345
|
450,013
|
|
Owner's Equity
|
|
|
|
|
|
|
|
Paid-in Capital
|
52
|
52,000
|
52,000
|
52,000
|
52
|
52,000
|
|
Retained Earnings
|
0
|
33,194
|
89,709
|
167,223
|
266.996
|
390,365
|
|
Total Liabilities & Equity
|
$520,000
|
$592,631
|
$687,496
|
$736,382
|
$804,341
|
$892,378
|