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Buckeye Computers Valuation Questions
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Buckeye Computer, Inc. (BCI) is introducing a new line of image generators and visual workstations in 2006. BCI’s revenues should grow by 15% per year through 2010. The line should yield operating profit margins of 14%.1 Because of rapid technological change in the industry, the product life cycle of the workstations is no more than 5 years. As a result, at the beginning of 2011, BCI will introduce a second generation of workstations with fully-integrated image generators based on research already under way. The second line is predicted, on average, to yield growth in revenue of 8% and operating profit margins of 12% starting in 2011 and lasting into the indefinite future [To be clear: Sales growth from 2010 to 2011 is 8% and this growth rate will be maintained from then on]. Other forecast ratios for BCI are given in Exhibit 2. BCI's past financial statements are given in Exhibit 1. The current rate of interest on risk free 30-day treasury bills is 4.8%. The yield on 10-year treasury bonds is 6.2%. Other companies that produce similar high performance image generators and visual workstations have on average equity betas of 0.9523. These firms have no net debt. Buckeye itself has an equity beta of 1.10. You will be evaluating the purchase of Buckeye Computer whose equity currently (end of 2005) has a market value of approximately $2,900 million (50 million shares at $58 each).
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#1
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What are the expected free cash flows for Buckeye for each year from 2006 through 2010?
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YearFree Cash Flow ($mm)
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2006 93.6
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2007 108.1
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2008 124.3
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2009 142.9
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2010 164.4
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#2
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Careful analysis of Buckeye's strategy, its markets and its dependence on outside sources of funding, software writers, customers, etc., suggests prudent worst case interest coverage (i.e., coverage that would not significantly impair operations) for Buckeye is 3. It is estimated that Buckeye will be able to borrow at a long-term interest rate of about 8.0% per year. Using this information, estimate the optimal capital structure (i.e. net debt to enterprise value ratio at market values) for BCI.
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ND/EV23%
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ND/E 0.2
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#3
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Estimate the equity beta for Buckeye post-purchase (i.e. at the optimal capital structure). Use this to estimate what BCI’s opportunity cost of equity capital will be. Finally, use this to estimate Buckeye's weighted average cost of capital, i.e., the discount rate for evaluating the purchase? Explain your calculations. As usual, use 5% for the market risk premium.
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Equity Beta1.2
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Opportunity Cost of Equity Capital
12.1%
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WACC12.8%
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#4
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Estimate the expected residual value at the end of 2010 for Buckeye as a growing perpetuity.
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Expected Residual Value ($mm) 5,718
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#5
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What is your valuation of Buckeye Computers and the value per share of its equity?
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EV ($mm) 3,567.2
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Equity Value ($mm) 2,855.8
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Value per share of Equity ($) 57.1
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