Corporate Valuation and Financial Planning

MINI CASE STUDY

Hatfield Medical Supplies’s stock price had been lagging its industry averages, so its board of
directors brought in a new CEO, Jaiden Lee. Lee had brought in Ashley Novak, a finance MBA who had
been working for a consulting company, to replace the old CFO, and Lee asked Ashley to develop the
financial planning section of the strategic plan. In her previous job, Novak’s primary task had been to
help clients develop financial forecasts, and that was one reason Lee hired her.
Novak began as she always did, by comparing Hatfield’s financial ratios to the industry averages.
If any ratio was substandard, she discussed it with the responsible manager to see what could be done to
improve the situation. The following data shows Hatfield’s latest financial statements plus some ratios
and other data that Novak plans to use in her analysis.

Hatfield Medical Supplies (Millions of Dollars Except Per Share Data)

Balance Sheet, 12/31/2013 Income Statement, Year Ending 2013
Cash $ 20 Sales $2,000
Accts. rec. 280 Op. costs (excl. depr.) 1,800
Inventories 400 Depreciation 50
Total CA $ 700 EBIT $ 150
Net fixed assets 500 Interest 40
$1,20
Total assets 0 Pretax earnings $ 110
Taxes (40%) 44
Accts. pay. & accruals $ 80 Net income $ 66
Line of credit $0
Total CL $ 80 Dividends $20.0
Long-term debt 500 Add. to RE $46.0
Total liabilities $ 580 Common shares 10.0
Common stock 420 EPS $6.60
Retained earnings 200 DPS $2.00
Total common equ. $620 Ending stock price $52.80
$1,20
Total liab. & equity 0
 Selected Additional Data for 2013
Hatfiel Industr
d y Hatfield Industry
Total liability/Total
Op. costs/Sales 90.0% 88.0% assets 48.3% 36.7%
Depr./FA 10.0% 12.0% Times interest earned 3.8 8.9
Cash/Sales 1.0% 1.0% Return on assets (ROA) 5.5% 10.2%
Receivables/Sales 14.0% 11.0% Profit margin (M) 3.30% 4.99%
Inventories/Sales 20.0% 15.0% Sales/Assets 1.67 2.04
Fixed assets/Sales 25.0% 22.0% Assets/Equity 1.94 1.56
Acc. pay. & accr. /
Sales 4.0% 4.0% Return on equity (ROE) 10.6% 16.1%
Tax rate 40.0% 40.0% P/E ratio 8.0 16.0
ROIC 8.0% 12.5%
NOPAT/Sales 4.5% 5.6%
Total op. capital/Sales 56.0% 45.0%

Note: Hatfield was operating at full capacity in 2013. Also, you may observe small differences in items like
the ROE when calculated in different ways. Any such differences are due to rounding, and they can be
ignored.

a. Using Hatfield’s data and its industry averages, how well run would you say Hatfield appears
to be in comparison with other firms in its industry? What are its primary strengths and
weaknesses? Be specific in your answer, and point to various ratios that support your
position. Also, use the Du Pont equation (see Chapter 3) as one part of your analysis.

b. Use the AFN equation to estimate Hatfield’s required new external capital for 2014 if the sale
growth rate is 10%. Assume that the firm’s 2013 ratios will remain the same in 2014. (Hint:
Hatfield was operating at full capacity in 2013.)

c. Define the term capital intensity. Explain how a decline in capital intensity would affect the
AFN, other things held constant. Would economies of scale combined with rapid growth
affect capital intensity, other things held constant? Also, explain how changes in each of the
following would affect AFN, holding other things constant: the growth rate, the amount of
accounts payable, the profit margin, and the payout ratio.
d. Define the term self-supporting growth rate. What is Hatfield’s self-supporting growth rate?
Would the self-supporting growth rate be affected by a change in the capital intensity ratio or
the other factors mentioned in the previous question? Other things held constant, would the
calculated capital intensity ratio change over time if the company were growing and were
also subject to economies of scale and/or lumpy assets?