Strategic Financial Management
Project #1
INSTRUCTIONS:
PROJECT #1: Equity Instruments
1. You have been asked to estimate the cost of equity for Hadley Holdings, a firm with operations in three different businesses – retailing, hotels, and travel. You have collected information on the firm’s operations and of comparable firms in each of the businesses.
Comparable Firms
Revenues
Unlevered Beta
Firm Value/Sales
Retailing
$400 Million
0.85
2.0
Software
$400 Million
1.15
3.0
Travel
$800 Million
1.35
1.25
a. Estimate the bottom-up unlevered beta for Hadley Holdings. ( 20 points)
. Hadley Holdings has no market-traded debt. The firm does, however, have $ 1.2 billion in book debt and an interest expense of $ 60 million. If the debt has an average maturity of 5 years, and the fair market rate for debt for the firm is 7%, estimate the market value of the debt. ( 20 points)
c. Hadley Holdings has 100 million shares outstanding trading at $ 10 a share. In conjunction with the estimated market value of debt in (b), estimate the bottom-up levered beta for the firm. (You can assume a marginal tax rate of 40% XXXXXXXXXXpoints)
2. Now assume that you have been asked to estimate the free cash flow to the firm last yea
for Hadley Holdings and have collected the following information.
• The firm reported earnings before interest, taxes, depreciation, and amortization of $350 million on its revenues of $ 1600 million.
• Depreciation and amortization charges amounted to $ 100 million and capital expenditures were $ 200 million.
• Hadley spent $ 100 million last year on research and development in its software division, following R&D expenditures of $ 60 million (3 years ago), $ 75 million (2 years ago), and $ 90 million (1 year ago) in the prior three years. You believe that research expenditures have an amortizable life of 3 years.
• The working capital items for the last year and the previous year are reported below.
Last Yea
Year Before Last
Cash
$100 Million
$80 Million
Accounts Receivable
$80 Million
$90 Million
Inventory
$150 Million
$100 Million
Accounts Payable
$130 Million
$110 Million
Short-Term Debt
$150 Million
$130 Million
• The tax rate for the firm is 40%.
a. Estimate the value of the research asset of the firm. ( 10 points)
. Estimate the operating income adjusted for R&D expenditures. (10 points)
c. Estimate the free cash flows to the firm last year. ( 30 points)
Answer all questions and show the necessary work. Please be
ief. This is an open book and open notes exam