Question

1. We find the following information on NPNG (No-Pain-No-Gain) Inc. (18 marks total)

• EBIT = $2,000,000
• Depreciation = $250,000
• Change in net working capital = $100,000
• Net capital spending = $300,000

These numbers are projected to increase at the following supernormal rates for the next three years, and 5% after the third year for the foreseeable future:

• EBIT: 10%
• Depreciation: 15%
• Change in net working capital: 20%
• Net capital spending: 15%

The firm’s tax rate is 35%, and it has 1,000,000 outstanding shares and $6,000,000 in debt. We have estimated the WACC to be 15%.

a.   Calculate the EBIT, Depreciation, Changes in NWC, and Net Capital Spending for the next four years.                                                                           

b.   Calculate the CFA* for each of the next four years, using the following formula:

CFA* = EBIT(1 – T) + Depr – ΔNWC – NCS                                                  

d.   Calculate the present value of growing perpetuity at Year 3.                   (1 mark)

e.   Calculate the firm’s value at time 0 using the WACC of the firm as the discount rate. (Note that the first CFA* to be discounted is the cash flow from one year into the future.)                                                                                           

f.   Calculate the firm’s equity value at time 0.                                                    (1 mark)

g.   Calculate the firm’s share price at time 0.                                           (1 mark)

Answer 1

a]

b]

d]

present value of growing perpetuity at year 3 = Year 4 CFA / (WACC - constant growth rate)

present value of growing perpetuity at year 3 = $1,555,529 / (15% - 5%) = $15,555,290

e]

Firm value at time 0 = present value of CFA of first 3 years + present value of growing perpetuity at year 0

present value of growing perpetuity at year 0 = present value of growing perpetuity at year 3 / (1 + WACC)³

present value of growing perpetuity at year 0 = $15,555,290 / 1.15³ = $10,227,856

present value of CFA of first 3 years = $3,093,741

Firm value at time 0 =   $10,227,856 + $3,093,741 = $13,321,597

f]

equity value = firm value - debt =  $13,321,597 - $6,000,000 = $7,321,597

g]

Share price = firm value / number of shares =  $13,321,597 / 1,000,000 = $13.32