Question

The owner of a private firm has requested that you estimate the value of the firm so that it can be marketed for sale. The firm creates custom, made-to-order furniture. The firm’s most recent results are shown in Appendix A.

Furniture Company
Income & FCF Analysis
($ in thousands )
	Most
	Recent
	Year
Revenue	$ 20,000
Cost of Goods Sold	15,500
Gross Profit Margin	4,500
Gross Profit Margin %	22.5%
General Operating Expenses	2,000
Depreciation & Amortization	500
Total Operating Expenses	2,500
Interest Expenses	1,000
Income before Taxes	1,000
Taxes	400
Tax Rate	40.0%
Net Income	$ 600
Add: After Tax Interest Expense	$ 600
Less: Capital Expenditures	(1,000)
Add: Depreciation	500
Add: Decrease (Increase) in AR	- - -
Add: Decrease (Increase) in Inv
Add: Increase (Decrease) in AP
Unlevered Free Cash Flows	$ 700

Management expects revenues, cost of goods sold, operating expenses, depreciation (and amortization), and capital expenditures to grow 20% annually for the next five years with taxes remaining at 40% for each year. Balance sheet items in the most recent year include $10 million of outstanding, interest-bearing debt and $10 million book value of equity. The outstanding debt is expected to remain constant for this analysis, and management anticipates no changes in working capital. Free cash flows are estimated to grow at 5% after the five year period.

Industry averages for market value of equity are three times book value, for beta are 1.30, and for market debt ratio are 20%. Average market multiple for the industry is 7 times net income, and the Treasury bond rate is assumed to be 7%.

Based on this information and the information covered in Unit 3, prepare a DCF and Market Multiple analysis (in Excel) to help the owner estimate firm value. Please make sure to include your calculations for the following items:

Annual Free Cash Flows

Cost of debt

Cost of equity

WACC

Terminal Value

Firm Value, Debt Value, and Equity Value

Would

the owner prefer the DCF or Market Multiple approach to valuation? Why?

Answer 1

Revenue	20000	24000	28800	34560	41472
Cost of good sold	15500	18600	22320	26784	32141
Gross profit margin	4500	5400	6480	7776	9331
%G.P	22.5%	22.5%	22.5%	22.5%	22.5%
Operating expenses	2000	2400	2880	3456	4147
Depreciation	500	600	720	864	1037
Total operating expenses	2500	3000	3600	4320	5184
Interest expense	1000	1200	1440	1728	2074
Income before tax	1000	1200	1440	1728	2073
Tax @40%	400	480	576	691.2	829.2
Net income	600	720	864	1036.8	1243.8
Add-:after tax expense	600	720	864	1036.8	1243.8
Less-:capital expenditure	1000	1200	1440	1728	2073
Add-: depreciation	500	600	720	864	1037
Free cash flowa	700	840	1008	12096	14516
Discount rate@7%	0.934	0.873	0.816	0.763	0.713

Interest expense is considered as capital expenditure.

Total annual cash flows=21788

Cost of debt =intt(1-tax)

= .07(1-0.4) =4.2%

Wacc=cost of equity *weight of equity+cost of debt *weight of debt

Firm value= operating free cash flows/(1+wacc)_t