Security Analysis and Portfolio Management Homework -
Question 1 - Annuity
Darryl Strawberry is a former professional baseball player. In 1985, Mr. Strawberry signed a $7 million contract with the New York Mets. As part of the compensation package, $700,000 of Mr. Strawberry's 1990 salary was deferred and placed into an annuity with an interest rate of 5.1%. While Mr. Strawberry excelled at hitting home runs and stealing bases, he struggled to pay his taxes. As a result of failing to pay over $600,000 in federal taxes, the IRS seized the annuity and auctioned it off to the highest bidder in January 2015. The winning bidder was to begin receiving payments in July 2015, so the winning bidder would receive 222 monthly payments of $8,891.82. The winning bidder is now being paid by the New York Mets.
a. What was the total face amount of the remaining payments beginning July 2015?
b. To determine the present value of the annuity as of January 2015, you'll need to download some yield curve data, which is available for free at www.treasury.gov. Yield curve data is not available for every month, so you'll need to make some assumptions to get a monthly time series of discount rates. Please state your assumptions, and plot the (monthly) yield curve as of January 2015.
c. Using the yield curve data from part (b), calculate the present value of the annuity as of January 2015. You can ignore credit risk.
d. It turns out that the winning bidder paid $1.3 million for the annuity. Is this higher or lower than the value you calculated in part (b)? What are some factors (financial and behavioral - hey, who wouldn't want to be paid by the Mets?) that could lead to the different valuations?
Question 2 - Another Annuity
The New York Mets seem to really like deferred compensation contracts. Before the start of the 2000 season, the Mets negotiated to buy out the final year of Bobby Bonilla's contract for $5.9 million. Rather than paying him $5.9 million at the time of the buyout in 2000, however, the buyout agreement called for the Mets to make 25 annual payments at 8% interest every July 1 beginning 10 years after Mr. Bonilla retired from MLB. You can think of this as a deferred 25 year annuity with an 8% annual interest rate. Mr. Bonilla retired in 2001, so the payments began July 1, 2011 and continues until July 1, 2035.
a. The annual payment was not set until after Mr. Bonilla retired. Find the annual payment such that the value of the annuity as of July 1, 2000 equals the original buyout amount of $5.9 million. Show your calculations. [Hint: your answer should be $x,xxx,xx8.20 with numbers in place of the x's, obviously]
b. What is the total face amount of the 25 annual payments?
c. Why would the Mets agree to this arrangement?
Question 3 - Equity Valuation
All you need to do is determine the fair price for a share of Nike stock. Write a short memo (less than one page) outlining your assumptions, conclusions, and a comparison to the actual price (on the date you complete the assignment).
This sounds simple, but you'll see that it's far from easy. You'll need to make some assumptions as you go, but try not to get carried away. You can start by making some rough assumptions and then refining them as needed. You should explicitly forecast free cash flows for the next 10 years. After that period, you can assume a reasonable perpetual growth rate. You're free to use any data or information you want, but it'll probably take a lot less time if you simply focus on the Valueline estimates. You can use the CAPM to estimate a discount rate.
To forecast after-tax operating free cash flow, use the historical data and forecasts from Value line to obtain estimates for the following:
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2017
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2018
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2019
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+Sales
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-COGS
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=Gross Margin
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-Other Expenses
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-Depreciation
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+/- Other
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=EBIT
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-Taxes
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=Earnings After Taxes
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+Depreciation
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-Capital Expenditures
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-/+Change in Working Capital
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-/+ Other
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=Free Cash Flow
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