Homework 2

Business Analysis and Valuation

Homework #2

Refer to the financial statements for UPS from the case, United Parcel Service’s IPO.

REQUIREMENT #1

Find the cost of equity capital (re) using the Capital Asset Pricing Model. Assumptions:

- The market premium is 6.8%

- The risk free rate is 4%

- Use the current beta for UPS. Hint: Got to Yahoo Finance, search for UPS and click on “key statistics”

IMPORTANT: Round all percentages to one (1) decimal point.

REQUIREMENT #2

Calculate abnormal earnings for three (3) years: 1999 – 2001. Assumptions:

- Net Income growth = 5%, 6% and 7% for each of the next three years

- Use the cost of equity capital (re) calculated in Requirement 1

REQUIREMENT #3

Calculate free cash flows to equity for three (3) years: 1999 – 2001. Assumptions:

- Change in long term assets = depreciation expense for 1998 for all three years (hint: use the change in accumulated depreciation)

- Change in working capital = 0

- The only change to equity is net income. The debt/equity ratio remains constant. (Hint: be sure to use both long-term debt and current maturities of short-term debt)

REQUIREMENT #4

Using an assumed perpetual growth rate of 3%, calculate the terminal value of UPS in 2001. Use free cash flows calculated in Requirement #3 in your calculation.

REQUIREMENT #5

Calculate the value of equity in 1998 using abnormal earnings for three (3) years calculated in Requirement #2.

REQUIREMENT #6

Calculate the value of equity in 1998 using free cash flows to equity for three (3) years calculated in Requirement #3.

REQUIREMENT #7

Calculate the price of a share of UPS stock in 1998 assuming the industry P/E ratio is 17.