ACC 650
Dr. Ken Lorek
Operational Guidelines for UPS Case Valuation Exercise

While alternative cash-flow proxies abound, I adopted the following proxy for CFO:
Net Income
+Depreciation and Amortization Expense
-Investment in Working Capital
-Capital Expenditures
Free Cash Flows

From Exhibit #7 of the case, I took the net income numbers for 1994-1998, respectively, and
divided them by 1.2 billion shares outstanding to determine relevant EPS numbers:
o Egs. For 1994 $943/1,200 = $0./79 EPS, etc.

For Depreciation Expense in 1999, I took the accumulated depreciation figure at the end of
1998 (8,170) and subtracted the accumulated depreciation figure at the end of 1997 (7,495) =
$675 which yielded depreciation expense for 1998. Assuming a constant 5% growth in capital
assets, depreciation expense for 1999 was estimated at $709 (675(1.05)). [Please note that the
5% growth rate is an arbitrary assumption for illustrative purposes. In your work the growth
rate would be determined based on your best estimate of future capital asset acquisitions given
the firm, industry and economy.]

For investment in working capital, I assumed that the net working capital increase in 1998
($1,708 - $1,079 = $629 remained constant throughout the forecast horizon. [Please note that
the constant growth rate assumption is arbitrary and for illustrative purposes. In your work the
growth rate would be determined based on your expectations pertaining to the firm’s future net
working capital balances.]

For Capital Expenditures, I took the net PP&E balance at the end of 1998 (11,384) and
subtracted the net PP&E balance at the end of 1997 (11,007) which yielded an increase in
capital expenditures of $377 during 1998. I assumed the same 5% growth rate employed above
during the forecast horizon.

Cost of Equity Calculation: On p. 5-51, the yield for 20-year U. S. treasury bonds was 6.5%
which I used as a proxy for the risk free rate of interest. The risk premium in the market during
the time period of the UPS IPO was approximately 3%. Note that historically the risk premium
has been approximately 6.7% across long windows of time so we probably need to test the
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sensitivity of our calculations to alternative risk premia. Note that I used the FedEx beta of 1.16
as a proxy for UPS’s beta.

For illustrative purposes, I have forecasted various elements of UPS’s financial performance over
a 5-year window. A 5 to 10 year forecast horizon should be sufficient for most firms. The
specific length of the forecast horizon is dictated by the competitive equilibrium assumption.

I assumed a terminal sales growth beyond 2003 of either zero or 4%. Estimates of terminal value
sales growth assumptions are influenced by the competitive equilibrium assumption.

Valuations based on PE Multiples:
o
Fed-Ex as the Benchmark
 1.78 (RW with hyperdrift prediction of 1999 EPS) X 19.8 (Fed-Ex PE) = $35.24
o
Best of Breed Benchmark
 1.78 X 37.2 (average of 6 BOB firms in Ex. #13) = $66.22
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