Question

Q2. Company B earned $20 million before interest and taxes on revenues of $60 million last year. Investment in fixed capital was $12 million, and depreciation was $8 million. Working capital investment was $3 million. The company expects earnings before interest and taxes (EBIT), investment in fixed and working capital, depreciation, and sales to grow at 12% per year for the next five years. After five years, the growth in sales, EBIT, and working capital investment will decline to a stable 4% per year, and investments in fixed capital and depreciation will offset each other. The company’s tax rate is 20%. Suppose that the weighted average cost of capital is 12% during the high growth stage and 8% during the stable stage. The calculation of FCFF in year 1 through year 5 is shown in the following table:

Year	0	1	2	3	4	5	6
Sales	60.00
EBIT	20
EBIT(1-T)	16
Depreciation	8
CAPEX	12
Change in working capital	3
FCFF

Finish the table and use WACC model to calculate the value of the company.(please show the details)(50 points)

Answer 1

FCFF = EBIT*(1 - tax rate) + Depreciation - investments in working capital - investments in fixed capital

From year 6 and beyond, investments in fixed capital and depreciation will offset each other. So in FCFF calculation same amount of depreciation and same amount of investments in fixed capital will be added and subtracted which will have net effect of zero in FCFF. hence in year 6 both investments in fixed capital and depreciation have been considered zero.

Terminal value is calculated for year 6 and beyond which is present value (PV) of FCFF of year 6 and beyond in year 6. hence terminal value needs to be discounted only for 5 years. Terminal value is calculated using weighted average cost of capital of 8% and growth rate of 4% during the stable stage but discounted using 12% in high growth stage of year 1-5.

Sum of PV of FCFF for year 1-5 and terminal value is value of the company at year 0 or current value of the company.

Below is the complete table:

Year	0	1	2	3	4	5	6
Sales	$60.00	$72.00	$86.40	$103.68	$124.42	$149.30	$155.27
EBIT	$20.00	$24.00	$28.80	$34.56	$41.47	$49.77	$51.76
EBIT(1-T)	$16.00	$19.20	$23.04	$27.65	$33.18	$39.81	$41.41
Depreciation	$8.00	$9.60	$11.52	$13.82	$16.59	$19.91	$0.00
CAPEX	$12.00	$14.40	$17.28	$20.74	$24.88	$29.86	$0.00
Change in working capital	$3.00	$3.60	$4.32	$5.18	$6.22	$7.46	$7.76
FCFF	$9.00	$10.80	$12.96	$15.55	$18.66	$22.39	$33.64
Terminal value	$0.00	$0.00	$0.00	$0.00	$0.00	$0.00	$841.05
PV of FCFF	$0.00	$9.64	$10.33	$11.07	$11.86	$12.71	$477.24
Value of company	$532.85

Below are the formulas and calculations: