MF620 Activity 6-09

ACTIVITY 6

MF620 Financial Statement Development and Analysis

 

Lesson 6: Creating Value

 

Activity 6:  Creating Value (4 pages 100 points)

Free Cash Inc. is anticipated to make earnings before interest and taxes (EBIT) of $30,000, $40,000, and $50,000 in each of the next three years. Depreciation is estimated to be $3,000, $3,500, and $4,000 in each of the next three years. Capital expenditures are estimated to be $8,000, $9,000, and $10,000 in each of the next three years. Incremental increases in working capital requirements are estimated to be $2,500, $3,000, and $3,500 in each of the next three years. Free Cash Inc.'s tax rate is 35 percent.

 

Part A         Estimate the free cash flows to the firm for Free Cash Inc. for each of the next three years.

 

Part B         Free Cash Inc.'s cost of capital is estimated to be 9 percent. Free cash flows beyond year 3 are estimated to grow at an annual rate of 4 percent. Using this information and that provided in Part A, apply the growing perpetuity formula to estimate the terminal value of Free Cash Inc. as of year 3.

 

Part C         Free Cash Inc.'s current value of existing debt is $58,996. Using this information and that provided in Parts A and B, estimate the value of the equity of Free Cash Inc. by applying the free cash flow to the firm method.

 

Part D         Estimate Free Cash Inc.'s year 3 terminal value by applying an EV/EBITDA multiple of 8.5 times to year 3 EBITDA.