Final Examination

Managing Corporate Finance

Topic: Business Valuation

Instructions: Analysis of the following case must be carried out using Microsoft Excel. Each student is required to submit their work in "Final Exam Submission Link - Week 5" no later than 11:59 p.m. on Sunday May 22. Late submissions will not be accepted whatsoever.

a. BigS Inc. is a retail firm with a hundred stores, many of which are not very profitable. The company reported $15 million in after-tax operating income on revenues of $ 500 million and total capital invested of $ 200 million in the most recent year. You can assume that both revenues and capital are spread equally across the hundred stores; each store accounts for $ 5 million in revenues and has $2 million in capital invested. The company currently has a high debt ratio (70% of capital, in market value terms) and a cost of capital of 10%. a. Assume that the firm plans to shut down ten unprofitable stores each year and fully recover the capital invested in these stores. Also assume that the unprofitable stores generate an after-tax operating margin (after-tax operating income/revenue x 100) of only 1.2%. Estimate the free cash flows to the firm each year for the next 5 years, assuming that revenues per store and the current margin at each store that remains open does not change.

b. At the end of year 5, BigS Inc. expects to be a mature company, growing 3% a year in perpetuity and to maintain the margin and after-tax return on capital from year 5 (part a). It also hopes to bring its debt ratio down to 40% and have a cost of capital of 8% in perpetuity, after year 5. Estimate the terminal value for the operating assets.

c. Use your answers from part a and b to estimate the fair market value of the business today.