Problems 467
An Employee Stock Ownership Plan, or ESOP, is a plan that facilitates employ-
ees’ ownership of stock in the company for which they work.
Questions
Define each of the following terms:
a.Assets-in-place; growth options; nonoperating assets
b.Net operating working capital; operating capital; NOPAT; free cash flow
c.Value of operations; horizon value; corporate valuation model
d.Value-based management; value drivers; ROIC
e.Managerial entrenchment; nonpecuniary benefits
f.Greenmail; poison pills; restricted voting rights
g.Stock option; ESOP
Explain how to use the corporate valuation model to find the price per share of common equity.
Explain how it is possible for sales growth to decrease the value of a profitable company.
What are some actions an entrenched management might take that would harm shareholders?
How is it possible for an employee stock option to be valuable even if the firm’s stock price fails
to meet shareholders’ expectations?
Self-Test Problem (Solution Appears in Appendix A)
Watkins Inc. has never paid a dividend, and when it might begin paying dividends is unknown.
Its current free cash flow is $100,000, and this FCF is expected to grow at a constant 7 percent
rate. The weighted average cost of capital is WACC 11%. Watkins currently holds $325,000
of nonoperating marketable securities. Its long-term debt is $1,000,000, but it has never issued
preferred stock.
a.Calculate Watkins’ value of operations.
b.Calculate the company’s total value.
c.Calculate the value of its common equity.
Problems
Use the following income statements and balance sheets to calculate Garnet Inc.’s free cash flow
for 2003.
12–1
FREE CASH FLOW
ST–1
CORPORATE VALUATION
12–5
12–4
12–3
12–2
12–1
Garnet Inc.
INCOMESTATEMENT 2003 2002
Net sales $530.0 $500.0
Costs (except depreciation) 400.0 380.0
Depreciation 30.0 25.0
Total operating costs $430.0 $405.0
Earnings before interest and taxes (EBIT) 100.0 95.0
Less interest 23.0 21.0
Earnings before taxes 77.0 74.0
Taxes (40%) 30.8 29.6
Net income $ 46.2 $ 44.4
464 Corporate Valuation, Value-Based Management, and Corporate Governance
