Question

Part A.

Suppose that ABC had the following sales growth: Sales in 2012: $0.6M; Sales in 2013: $20M; Sales in 2014: $50M; Sales in 2015: $100M; Sales in 2016: $55M; settling to a constant growth rate of 2% forever. Thanks to its business model, the company has no inventory or accounts receivables. It books and collects 100% of all sales initially but needs to pay 70% of all sales to the creative entrepreneurs 60 days after the sale. Suppose ABC spends an additional 10% of its sales revenue on SG&A, faces a 30% tax rate, and there are 365 days in a year. What was ABC's free cash flow in 2012? What was ABC's free cash flow in 2017?

Part B.

ABC is all equity financed, has a beta of 2, the risk-free rate is 2%, and the market risk premium is 6%, estimate ABC's valuation as of January 1st 2012. Assume that the firm's fiscal year matches up with the traditional calendar year such that you are valuing the firm on Jan 1st 2012 (period 0) and the first free cash flow occurs on Dec 31st 2012 (period 1).

Answer 1

As ABC collects 100% of the sales amounts in the year itself, thus there won't be any debtors in the Balance Sheet.

ABC
Projected Profit & Loss Statement						INR in million
				1	2	3	4	5
				2012	2013	2014	2015	2016	2017
	Sales			0.6	20	50	100	55	56.1
Less	Expenses to Creative enterpreneurs	-0.42	-14	-35	-70	-38.5	-39.27
Less	SG&A			-0.06	-2	-5	-10	-5.5	-5.61
	EBIT			0.12	4	10	20	11	11.22
Less	Tax		30%	0.036	1.2	3	6	3.3	3.366
	EAT			0.084	2.8	7	14	7.7	7.854

As ABC is equit financed, therefore Free Cash Flow to Firm will be equal to the Free Cash Flow to Equity.

The discounting factor used is Cost of Equity i.e. Ke

Calculation of Cost of Equity (Ke)
Risk free rate (Rf)			2%
Beta (B)			2
Market Risk Premium (Rm-Rf)			6%
Ke = Rf + B(Rm-Rf)			14.00%

As 70% of sales amount is paid to creative enterpreneurs with crdit of 60 days, there will be creditors in Balance Sheet at the end of the year equal to [Amount to be paid to enterpreneurs *60/365]

Statement of Creditors							INR in million
		2012	2013	2014	2015	2016	2017
Total Payment to Creative Enterpreneurs		0.42	14	35	70	38.5	39.27
Payment due at the end of the year		0.07	2.30	5.75	11.51	6.33	6.46

As the business life is infinite and after the end of year 5, the company will grow at a constant rate of 2%, therefore terminal value will be calculated by the formula [CF1 / (Ke-g)] where CF1 = 7.98/-, Ke = 14%, g= 2%

Calculation of Free Cash Flow to Firm						INR in million
				2012	2013	2014	2015	2016	2017
	EAT			0.084	2.8	7	14	7.7	7.854
	Adjustment of Creditors	0.07	2.23	3.45	5.75	-5.18	0.13
	FCFF			0.15	5.03	10.45	19.75	2.52	7.98
	Growth rate	2%
	Discounting Factor (Ke)	14.00%
	Present value Factor		0.88	0.77	0.67	0.59	0.52
	Value			0.13	3.87	7.05	11.70	1.31
	Total Cash Flow		24.07
	Terminal Value		34.54
	Value of the firm		58.61