Itw patent society

i. Description of the company, industry, and market in the case to understand why the issues occurred.

In 1912, an investor by the name of Byron Smith published an ad in a local newspaper called the Economist. In this ad, Bryon was looking for a business where he could invest some capital. He was interested in investing preferably in manufacturing. There were many proposals that Bryon turned down, he was still patiently waiting for the perfect proposal. Finally one day a group of investors presented Bryon the idea of a business where they would improve gear grinding, and thus, Illinois Tool Works was born. Illinois Tool Works has survived wars and recessions, as well as successfully expanding the company across the globe. Illinois Tool Works has helped industries transform through simple but ingenious solutions.

By 1920, ITW made their first acquisition; they acquired Shakeproof Screw and Nut Lock Company, which offered innovative washers that resolved persistent auto manufacturing problems. In 1930, ITW became the first manufacturing company to advertise in mainstream publications. The successful management of the company allowed them the opportunity to report profits every year during the Great Depression. In 1940, the company contributed to World War II by developing an advanced water cutter that facilitated faster manufacturing of heavy artillery barrels. ITW’s presence was announced on local radios in the 1960’s. They also entered the construction industry by offering the first self-drilling door screw opener and the Hi-Cone six-ring carrier, making it the most successful and well-known inventions that transformed the beverage and packaging industries. The company was listed on the New York Stock Exchange and became publicly traded in 1970.

In addition to being publicly traded, the company established the ITW patent society to honor their greatest innovators. ITW has successfully attained close to 100 worldwide acquisitions, expanding their global presence. They have established presences in every corner of the globe including emerging markets like Brazil, Russia, India and China. Miller Electric welding company and Premark International are ITW’s major acquisitions which expanded the company to reach the emerging welding and food industries. ITW segments are composed of the auto, construction, food equipment, welding, polymer and fluid industries, along with being one of top U.S. patent holders.

ii. Description of natures of the issues in the case.

iii. Answers to questions in the case

Question 1:

Question 2:

Question 3:

iv. Answers to at least 2 additional self-selected questions relevant to the issues in the case.

v. Conclusion

C6-1: As described in the chapter, the abnormal earnings approach for estimating common share value is

https://lh6.googleusercontent.com/MGzrAjFqjjU66ihfrprYZGh2NtU1pDJrwKZXSKBpODQUX-_yq4ZIZbsoylaNdvgnLS6vozFxPZMQPMzn2T-DAWiqlJXa6kbvi4vxzODnmwkH_i5ZnNjZcoC-Ti5wL80mktq8t0Ws

where V0 is the total value of all outstanding shares, BV0 is the current book value of stockholders’ equity, BVt-1 is the book value of shareholders’ equity at the beginning of period t, re is the cost of equity capital, E0 is the expectations operator, and Xt is period t net income.

The model says that share value equals the book value of stockholders’ equity plus the present

value of future expected abnormal earnings (where abnormal earnings is net income minus the cost of equity capital multiplied by the beginning-of-period book value of stockholders’

equity).

The model is silent on how one comes up with expected net income for future years (and therefore future expected abnormal earnings) and just how many future years should be used.

Because of the way present value is calculated, abnormal earnings amounts expected for years

in the distant future have a small present value and are essentially irrelevant to valuation, especially if abnormal earnings are close to zero in the long run, as many analysts assume.

Thus, professional analysts rarely use more than 15 years, often fewer than 10.

Comparative income statements and retained earnings statements for Illinois Tool Works

(ITW) for Year 1–Year 3 follow.

Required:

1. Assume a 10-year forecasting horizon. Note that ITW’s Year 3 return on beginning stockholders’ equity (net income divided by beginning Year 3 stockholders’ equity), adjusted to exclude unusual items and their tax effects, is 9.5%. (If we add $337 × 0.65 = $219 back to net income, we get $713 + $219 = $932 of adjusted net income. Dividing that amount by $9,823 gives 9.5%.) Assume return on beginning stockholders’ equity will persist at 9.5% throughout the forecasting horizon, with no additional unusual items. That is, expected net income is always equal to 0.095 multiplied by beginning-of-the-year stockholders’ equity. Also assume that no additional stock issuances or repurchases are made and that dividends equal 25% of net income in each year. (This is ITW’s approximate historical dividend payout ratio.) Given these assumptions, the book value of stockholders’ equity at the end of Year 4 equals book value at the beginning of Year 4 plus (1 − 0.25) times Year 4 net income. Finally assume that the cost of equity capital is 9%. (This is ITW’s approximate cost of equity capital.) With these relatively simple assumptions, use the abnormal earnings model to estimate the total value of Illinois Tool Works’ common shares as of the end of Year 3. Ignore terminal values at the end of the 10-year forecast horizon in your calculations.