Question

Railback Battery Systems Following is the seven-year forecast for a new venture called Railback Battery Systems:

Year	2020	2021	2022	2023	2024	2025	2026
EBIT	($1,000)	($900)	$200	$1,200	$2,500	$3,000	$3,050
Capital Expenditures	$550	$350	$200	$175	$175	$160	$150
Changes in Working Capital	$400	$300	$200	$100	$100	($100)	($100)
Depreciation	$40	$80	$125	$150	$150	$150	$150

Part 1:

Beginning after year 2026 the annual growth in EBIT is expected to be 1.5%, a rate that is projected to be constant over Railback's life as an enterprise. Beginning in 2026 Railback's capital expenditures and depreciation are expected to offset each other (capex - depreciation = 0) and year to year changes in working capital are expected to be zero (working capital levels remain constant year over year). For discounting purposes consider 2020 as year 1. Assume a tax rate is 21% and a cost of capital of 7.75% Question: Determine the NPV of Railback Battery Systems Free Cash Flow for the years 2020 - 2026. HINT: Remember to account for loss carry-forwards when determining income taxes. The answer to this question was determined in Excel. Your answer may deviate slightly depending upon differences in truncation and rounding. Answers below are in $000.

Part 2:

Calculate the fair market value (NPV) for Railback Battery Systems. For this problem assume that the Net Present Value of Railback's free cash flow for the period 2020 - 2026 is $3000 (NOTE its not $3000 but make this assumption in case the answer you determined in the first question was incorrect. Assume no underlying changes to any of the data in the problem. DO NOT USE YOUR ANSWER FROM THE QUESTION ABOVE. All ANSWERS ARE IN $000

Answer 1

Part (1)

Please see the table below. The last line highlighted in yellow is the answer.

Taxes have been calculated after recovery of accumulated losses.

Count	1	2	3	4	5	6	7
Year	2020	2021	2022	2023	2024	2025	2026
EBIT	(1,000)	(900)	200	1,200	2,500	3,000	3,050
Capital Expenditures	550	350	200	175	175	160	150
Changes in Working Capital	400	300	200	100	100	(100)	(100)
Depreciation	40	80	125	150	150	150	150
Accumulated EBIT	(1,000)	(1,900)	(1,700)	(500)	2,000	5,000	8,050
Taxes	-	-	-	-	420	630	641
FCFF	(1,910)	(1,470)	(75)	1,075	1,955	2,460	2,510
Cost of capital	7.75%
Discount factor	0.9281	0.8613	0.7994	0.7419	0.6885	0.6390	0.5930
PV of FCFF	(1,773)	(1,266)	(60)	798	1,346	1,572	1,488
NPV of FCFF over 2020 to 2026	2,105

Part (2)

FCFF₂₀₂₇ = EBIT₂₀₂₆ x (1 + g) x (1 - tax rate) - (Capex - depreciation) - change in working capital = 3,050 x (1 + 1.5%) x (1 - 21%) - 0 - 0 =  2,445.64

Horizon value of FCFF at the end of 2026 = HV₂₀₂₆ = FCFF₂₀₂₇ / (r - g) = 2,445.64 / (7.75% - 1.5%) =  39,130

Hence, PV of horizon value = HV₂₀₂₆ / (1 + r)⁷ =  39,130 / (1 + 7.75%)⁷ =  23,206

The fair market value (NPV) for Railback Battery Systems = Net Present Value of Railback's free cash flow for the period 2020 - 2026 + PV of horizon value = $ 3,000 + 23,206 =  26,206