Interco Case Study

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Grade 9,0
Corporate Finance II

Advanced Valuation

Comments from teacher: In question 1, why do we use these equitation’s, explain and show then, i.e. ROE can go up with more leverage. More on comparables. In Q1 assumptions explained, that are then used in DCF. Max for question 1 and 2, two pages. Must power to put in Q3. Deduct tax in table 3. In DCF, show more how calculated and assumption missing about other income and corporate expenses. Table 6 to be fixed (already been done). Skip in DCF advantage and disadvantage. Do table 4 different, use Exhibit 11, value range, use median value and calculate enterprise value with multiples en deduct net debt 318,5 and get equity value. Explain better in main text footnote 12. . Use word „discount rate“, not „discount factor“

Date 04.03.2010

Assess Interco’s financial performance Interco’s overall financial performance for the period 1986 to 19881 is robust represented by rapid revenue growth and stable cash flows. Fiscal year 1988 was solid, net sales increased by 13,4% and the company had healthy operating margins. In the same period operating cash flow had a steady level of 9,6% of net sales. ROE increased to 11,6%, but was still below the target of 14-15%. Table 1 - Operating ratios 1986 1987 1988 1Q ´88 Net sales Growth na 4,0% 13,4% -0,4% Operating income growth na 7,0% 10,3% 1,7% Operating cash flow growth na 7,2% 11,2% Operating income margin 7,7% 7,9% 7,7% Operating cash flow margin 9,5% 9,7% 9,6% ROE 9,4% 9,5% 11,6% * 1Q growth is between relevant quarters in 1987 and 1988 Source: Exhibit 7


When analysing Interco’s operating groups separately2, table 2 below, it is clear that the general retail and apparel businesses are struggling, not contributing to the financial performance, while the footwear and furniture businesses have been performing well. Table 2 Apparel 1987 - 1988 operating ratios 1987 1988 Net sales growth -9,9% -0,5% Operating earnings growth -29,1% -57,2% Operating earnings margin 5,8% 2,5% Source: Exhibit 8

General retail 1987 1988 7,9% 6,8% 26,6% -3,7% 8,1% 7,3%

Footwear 1987 1988 18,8% 34,2% 7,6% 76,9% 7,9% 10,4%

Furniture 1987 1988 7,0% 14,3% 17,7% 20,5% 12,8% 13,5%

The apparel business had suffered a decrease in net sales by 0,5% and the operating margin decreased heavily to 2,5% in 1988. The general retail business had marginal decrease in growth rate and operating margin decreased to a level of 7,3%. Despite restructuring efforts the two businesses were ongoing problems for Interco. Interco’s overall financial performance was driven by the contributions of furniture and home furnishings and footwear businesses, as well as a decrease in effective tax rate. Footwear net sales increased by 34,2% in 1988, while reaching robust operating margins. This performance was largely supported by Converse, acquired in September 1986. The furniture unit also contributed strong growth rate of 14,3% in 1988 and increased level of operating margin. The outlook for the furniture unit was very positive due to favourable economic trends.3

1 2

Case problems in finance, Kester page 582, exhibit 7 Case problems in finance, Kester page 583, exhibit 8 3 Case problems in finance, Kester, page 575


Table 3 shows the return on investment (ROI) for each division and the overall company.4 The apparel has the lowest ROI, result of low operating income and high asset base. The general retail’s ROI is in line with the overall company, result of significantly lower asset base. Eliminating both the Table 3 - 1988($´000) Apparel Gen.retail Footwear Furniture Operating income 20.240 39.101 92.204 149.090 Identifiable assets 425.350 252.195 595.861 688.853 ROI 4,8% 15,5% 15,5% 21,6%

apparel and the general retail would increase the company’s ROI from 14,5% to 17,4%.5

Equity analysts viewed Interco as a over-capitalized conservative company. Interco had debt capitalization of 19,3% and a current ratio of 3,6 in the fiscal...
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