CASE BRIEF

CASE BRIEF (CONTD)

OUR TARGETS
Economy and equity market analysis

Industry analysis (Porters 5 forces Model)

Company Analysis (SWOT & DuPont)

Price estimation

ECONOMY & EQUITY MARKET ANALYSIS

In early 1977, indicators in market pointed toward recovery from 1975 recession.

Consumer Price Index rose by a seasonally adjusted annual rate of 9.6%.

Inflation rate not more than 6%.

Favorable equity market climate for falling interest and Bond coupon rate.

Expected growth of price in equity market from 10 to 20%.

INDUSTRY ANALYSIS (PORTERS 5 FORCES)

Threat of new entrant

(may exist)
Threat of substitute product
(low)

Bargaining power of buyer

No need of much capital for starting food stores

(capital of only $23,82,000 for Hop-In)
mostly same product line among competitors
(grocery, retail food, convenience food stores)

competitive price of products in the industry

(low)
Bargaining power of supplier
(can be reduced)

Rivalry
(high)

after going public, bargaining power of lenders

(supplier of capital) expected to be reduced.
high rivalry among competitors according to
price of products.

COMPANY ANALYSIS (SWOT)

Strengths:
Lower price of gasoline
Avoiding higher cost and risk of
new store by acquisition of
established ones.
Advertising cost low for nature of
product line.

Opportunities:
falling bond coupon and
interest rate
Inflation rate not so high (6%)
Optimistic equity market
condition

Weaknesses:
not audited by any of big 8
firms.
distribution of shares limited
geographically
lack of established dividend
policy

Threats:
threat of takeover from
petroleum companies
Greater financial resources of
competitors

COMPANY ANALYSIS (DUPONT)

ROE = Net income / Net worth
= Tax burden * Interest burden * Margin * Turnover * Equity Multiplier
= (Net profit after taxes / pretax profit) * (Pretax profit / EBIT) *(EBIT /Sales)*
(Net sales / total assets) * (total assets/Net worth)
= (280,562 / 453,562) * (453,562 / 539,995) * (539,995 / 13,960,607) *
(13,960,607 / 4,187,720) * (4,187,720 / 1,254,000)
= 0.62 * 0.84 * 0.038 * 3.33 * 3.34

Tax burden
= 62 % of pretax profit
(Profit retained after tax payment)
Interest Burden
= 84 % of EBIT
Profit Margin
= 3.8 % on sales
Asset turnover
= 3.33 times
Equity Multiplier
= 3.34 times
Leverage Ratio = (3.34 1) times = 2.34 times of net worth

PRICE ESTIMATION

Given financial
statements in the
case

Multiple Analysis
(Price Earnings
Ratio)

Dividend Discount
model to estimate
cost of equity

Weighted Average
Cost of Capital

Price to Book
value Ratio

Discounted Cash
Flow Method

ASSUMPTION & CALCULATION

Net Sales = (Grocery + gasoline + Equipment)
= $(11,466,085 + 2,477,427 + 17,095)
= $13,960,607

% increase in money order commission =

(1976 comm. -1975 comm.) / 1975 comm. =
(21,431 11,260) / 11,260 = 90 %

% increase in grocery sales = (1976 sales-1975

sales) / 1975 sales = (11,466,085 - 8,565,668) /
8,565,668 = 34 %

% of cost of grocery sales on grocery sales =

cost of grocery sales / grocery sales =
7,685,318 / 11,466,085 = 67 %

% increase in gasoline sales = (1976 sales-1975

sales) / 1975 sales = (2,477,427 1,445,826) /
1,445,826 = 71 %

% of cost of gasoline sales on gasoline sales =

cost of gasoline sales / gasoline sales =
2,317,334 / 2,477,427 = 94 %

% of gasoline commission on gasoline sales =

commission / gasoline sales = 95,846 /
2,477,427 = 0.38 %

% of cost of equipment sales on equipment

sales = cost of equip. sales / equip. sales
= 14082 / 17095= 82 %

ASSUMPTION & CALCULATION (CONTD)

% increase in operating, general &
administrative expenses = (1976 expenses 1975 expenses) / 1975 expenses = (3,364,258
2,497,104) / 2,497,104 = 35 %

Total Debt = (Long Term debt + Short term

Debt) = $(551,000 + 577,000) =$1,128,000

% increase in Depreciation = (1976 dep. -1975

dep.) / 1975 dep. = (202761 148991) /
148991 = 36 %

Net equipment sales of subsequent years are

assumed to be as same as that of year 1976
which is $17,095

% of income tax of year 1976 = income tax /

income before income tax = 173,000 / 453,562
= 38 %

% increase in other income = (1976 oth. inc. 1975 oth. inc.) / 1975 oth. Inc. = (45,864
24,964) / 24,964 = 84 %

All calculations are based on year 1975 and

year 1976

Inflation Rate is not used to calculate

Discounting Rate

CHANGE IN NET WORKING CAPITAL

NWC 1,
NWC of 1976 (year ended June 30) = Current asset Current liability
= (1,766,180 2,154,519)
= -388,339
NWC 2,
NWC of 1976 (6-months ended December 30) = Curr. asset Curr. liability
= (1,864,038 2,245,255)
= -381,217
% CNWC for 6-months = (NWC 2 NWC 1) / NWC 1
= (-381,217 + 388,339) / (-388339)
= -1.83 %
Annual % CNWC = (-1.83*2) %
= -3.7%

Year

Net Working
Capital

CNWC

1976

-388,339

1977

-373,970

14,369

1978

-360,134

13,837

1979

-346,809

13,325

1980

-333,977

12,832

1981

-321,620

12,357

CAPITAL EXPENDITURE

Property and equipment of 1976 (6-months ended December 30) = $2,930,544

(-)Property and equipment of 1976 (year ended June 30)
= $2,644,162
(-)Equipment Sale in (year ended June 30)
= $17,095
________________________________________________________________
Purchase of property and equipment in 6 months
= $269,287
Purchase of property and equipment in 1 year = $(269287*2) = $538,574

COST OF EQUITY (DDM)

Dividend rate
(per share)

Serial No. Competitors' Name

1
2
3
4
5
6

Southland Corporation
Munford, Inc.
Dillon Companies
Sunshine-JR stores, Inc.
National Convenience Stores, Inc.
Circle k food stores, Inc
Total
Average Dividend Rate

0.37
0.35
0.96
0.20
0
0.51
2.39
0.4

Return on Equity, ROE = Net income / Net worth = 22.38% (Given)

Growth rate of dividend, g = Return on Equity * (1 Dividend rate)
= 0.2238 * (1 0.4)
= 13 %
Net earnings (per share) of year 1976 = $1.55
Current year dividend, D0 = $(1.55 * 0.4) = 0.62
D1 = D0 * (1+g) = 0.62 (1+0.13) = 0.70
Current price at informal market, P0 = $9.50
Cost of Equity, ke = D1/ P0 + g = (0.70/9.50) + 0.13 = 20.31%

WEIGHTED AVERAGE COST OF CAPITAL

Given that,
% of Debt Capital (Short term +Lon term), Wd = 47%
% of Equity Capital, We
= 53%
Total capital
= 100%

Average Cost of Debt, Kd = Interest Exp. / Total Debt

= Interest exp / (Long Term + Short term Debt)
= 86,433 / (551,000 + 577,000)
=7.7 %

After Tax Cost of Debt

= Kd (1- tc) = 0.077 (1-0.38)
= 4.8 %

Weighted Average Cost of Capital, WACC = We * Ke + Wd * Kd (1- tc)

= 0.53 * 0.2031 + 0.077 * 0.048 = 11%

PRICE ESTIMATION (DCF)

Actual
Particulars
Revenue:
Net Grocery Sales
Net gasoline sales
Gasoline
commissions
Net equipment
sales
Money order
commissions
Total revenue
Less: Costs and
expenses:
Cost of sales
Grocery
Gasoline
Equipment
Total cost of sales
Operating, general
and administrative
Depreciation
Total costs and
expenses
Operating profit
Other income
Income before
income taxes
Less: Income taxes
Net Income after
tax

Estimated

1975

1976

1977

1978

1979

1980

1981

8,565,668
1,445,826

11,466,085
2,477,427

15,364,554
4,236,400

20,588,502
7,244,244

27,588,593
12,387,658

36,968,715
21,182,895

49,538,078
36,222,750

87,389

95,846

16,098

27,528

47,073

80,495

137,646

231,905

17,095

17,095

17,095

17,095

17,095

17,095

11,260
10,342,048

21,431
14,077,884

40,719
19,674,866

77,366
27,954,736

146,995
40,187,414

279,291
58,528,490

530,653
86,446,222

5,936,491
1,298,581
204,186
7,439,258

7,685,318
2,317,334
14,082
10,016,734

10,294,251
3,982,216
14,082
14,290,549

13,794,296
6,809,590
14,082
20,617,968

18,484,357
11,644,398
14,082
30,142,838

24,769,039
19,911,921
14,082
44,695,042

33,190,512
34,049,385
14,082
67,253,979

2,497,104
148,991

3,364,258
202,761

4,541,748
275,755

6,131,360
375,027

8,277,336
510,036

11,174,404
693,649

15,085,445
943,363

10,085,353
256,695
24,964

13,583,753
494,131
45,864

19,108,053
566,814
84,390

27,124,355
830,380
155,277

38,930,210
1,257,204
285,710

56,563,095
1,965,395
525,706

83,282,788
3,163,434
967,300

281,659
66,890

539,995
173,000

651,204
247,457

985,658
374,550

1,542,914
586,307

2,491,101
946,619

4,130,734
1,569,679

214,769

366,995

403,746

611,108

956,607

1,544,483

2,561,055

Terminal
Value

PRICE ESTIMATION (DCF) CONTD

Actual
Particulars
Net Income after
tax

Estimated

1975

1976

1977

1978

1979

1980

1981

214,769

366,995

403,746

611,108

956,607

1,544,483

2,561,055

Less: Change in
Net Working
Capital

14,369

13,837

13,325

12,832

12,357

Less: Capital
Expenditures

538,574

538,574

538,574

538,574

538,574

Free Cash Flow

(Unlevered cash
flow)
Present Values

Enterprize Value

-149,197
-134,412

404,708
295,919

993,077
654,170

2,010,124
1,192,911

12

21

12,900,871

Add: Ending
Cash Balance

209,930

Less: Debt
Outstanding
Equity Value

1,128,000
11,982,801

Total share
outstanding

124,657

Estimated Value
per Share
Proforma net
income per share
(EPS)

58,697
47,640

96

3.34

Terminal
Value

18,273,855
10,844,644

DCF (TERMINAL VALUE)

Terminal Value = Free Cash Flow of year 1981 / WACC

= 2,010,124/ 0.11
= 18,273,855
Free cash Flow of Year 1981 is assumed to be as same as
that of year 1980

PRICE ESTIMATION (P/E RATIO)

Competitors' average price earnings ratio:
Serial No.
1
2
3
4
5
6

Competitors' Name
Southland Corporation
Munford, Inc.
Dillon Companies
Sunshine-JR stores, Inc.
National Convenience Stores,
Inc.
Circle k food stores, Inc
Total
Average

Price-Earnings (P/E)
Ratio
14.5 x
6
13
6
7
5
37
6

Price earnings ratio = ( Market Value per share/ Earnings per share)
Hop-In Food Store, Inc.'s estimated market value per share
= Average estimated EPS * Competitors' average P/E Ratio
= $3.34 * 6
= $20

PRICE ESTIMATION (P/B RATIO)

Competitors' average Price to Book value ratio:
Serial no.
1
2
3
4
5

Name of the Company

Southland
Munford

Dillon
Sunshine Junior
National Convenience
Stores

Book value / Market Value /

Market value Book value(B)
0.54
1.85
1.38
0.72
0.30
3.33
1.17
0.85
1.11
0.90

6
Circle K
1.06
Total Market Value / Book Value of Industry
Avg. Market Value / Book Value of Industry

0.94
8.59
1.43

Share Price = (Market Value / Book Value) of Industry * Book Value of the Company
= 1.43 * $10.06
= $ 14.39

PRICE ESTIMATION
Comparison among different methods:
Methods
Price Earning Multiplier

Hop-In Food Share

Price
$ 20

Price to Book value Ratio

$ 14.39

Discounted Cash Flow

Range of Price
Intrinsic value to investors

$ 96
$ 14.39 to $ 20
$96

Here we see the price range is $ 14.39 to $ 20, but to investors the
value may be $96.
The average of the prices = (14.39+20+96)/3 = 43.46
So, we can suggest $40 as offer price per share.