Hampton Tool Vs Inc Case Study Essay

Question1.
NPV = FCF1/(1+WACC)+FCF2/(1+WACC)^2+FCF3/(1+WACC)^3+FCF4/(1+WACC)^4+FCF5/(1+WACC)^5 +FCFp, where FCF1…FCF5 are the free cash flows in years from 1999 to 2003.
FCF = Cash flow from Operations – increase in net working capital requirement – capital expenditures, discounted by WACC. For example, in 1999 FCF1 = (7965 – 516 – 4938)/(1+0,1) = 2283.
Similarly, we calculate FCF2=2479, FCF3=2666, FCF4=3007, FCF5=3132.
As we assume, that after 2003 the FCF will grow permanently by 4% by year to the infinity, we can calculate FCFp as perpetuity: FCFp = FCF2004/(WACC-g) = 54288
So finally, we got NPV = 67855 and can calculate EV = NPV + WCR (1999)
EV = 81275, which is the maximum price for the Hampton Tool, that Lycos should be willing
to pay.

Question2.
Part1
Data Inc. has $40 billion of equity and $60 billion of debt currently. So the initial leverage (D/V) is 60%.
We can calculate the cost of equity using this formula: WACC = ke * E/V + kd *(1-t) *D/V. ke = the cost of equity = 20%
Using the same formula we calculate WACC, when the leverage is 20%: WACC =
17,2%
Part2
To change leverage from 60% to 20%, Data Inc. is needed to buy back $50 billion of debt, so the leverage will be 10/(10+40) = 20%, the company’s value will decrease to $50 billion. From the other hand, Data Inc. can issue $240 billion of equity, so the leverage will be 60/(60+240) = 20%.
Question3. Part1
Sources and uses exhibit
Retained Earnings = Net income less preferred dividends
Other funds = Deferred taxes +employee stock purchase plan
Increase in adjusted working capital = working capital – cash – short-term debt FY1984 FY1985 FY1986 FY1987 FY1988
A.
Funds from operations
Retained Earnings 210 235 371 588 731
Depreciation 173 272 412 601 749
Other 65 88 106 120 140
Total 448 595 889 1309 1620
B. External financing
Net increase in lease obligations 0 0 0 0 0
Other net borrowing, sale of securities 0 0 0 0 0
Total 0 0 0 0 0
Total uses 448 595 889 1309 1620
C. Uses of funds
Investment in plant, equipment 890 1467 1931 2760 1457
Acquisitions 0 0 0 0 0
Increase in adjusted working capital 0 0 0 0 0
Change in cash holdings 0 0 0 0 0
Total uses 890 1467 1931 2760 1457

So, providing an analysis, based on the exhibit, we assume that the need of external capital for MCI will be: FY1984 FY1985 FY1986 FY1987 FY1988
Need in external capital 442 872 1042 1451 (163)
With the total need of external capital of 3644
Question3. Part2
We compare two alternatives:
1. $500 million of 12,5%, 20 year subordinated debentures
2. $400 million of common stock
Assume, that the WACC is 12,6% and the tax rate is 46%. Straight debt Common
stock
Taxable income 1 2
Financial distress costs 2 1
Agency cost of equity 1 2
Undervalued stock 1 2
Overvalued stock 2 1

As the income will constantly grow during the period, we concern its taxation as important.
Financial distress costs are important maily because of the industry and special assets.
Agency costs of equity are important because the high investments in building and equipment are expected
Under| Over valued stocks
I suppose, that the debt alternative is better for the MCI, because it can provide $100 million more capital, will decrease the tax expenses and the debt rate is lower than WACC.