Question

9.        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%.

1. 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:

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

Answers of questions a,b,d and e are in the below table.

f. Firm's equity value = firm's value - value of debt = $13,321,597 - $6,000,000 = $7,321,597

g. Firm's share price = Firm's equity value/no. of shares outstanding = $7,321,597/1,000,000 = $7.32

Calculations of questions a,b,d and e

Year	0	1	2	3	4
EBIT	$2,000,000	$2,200,000	$2,420,000	$2,662,000	$2,795,100
EBIT(1-Tax rate)	$1,300,000	$1,430,000	$1,573,000	$1,730,300	$1,816,815
Depreciation	$250,000	$287,500	$330,625	$380,219	$399,230
Change in net working capital	$100,000	$120,000	$144,000	$172,800	$181,440
Net Capital spending	$300,000	$345,000	$396,750	$456,263	$479,076
CFA	$1,150,000	$1,252,500	$1,362,875	$1,481,456	$1,555,529
Value of growing perpetuity	$0	$0	$0	$0	$15,555,291
PV of CFA and growing perpetuity	$0	$1,089,130	$1,030,529	$974,082	$10,227,856
Value of company	$13,321,597.35

Formulas

Value of growing perpetuity is at the end of 3 years calculated using year 4 CFA, WACC and growth rate for foreseeable future. so it has been discounted only for 3 years.