Question

Summit Energy is an alternative energy producer. Your hedge fund is interested in investing into the company. As an analyst, you need to estimate firm value and its price per share using the NPV method and report it to the energy portfolio manager. So far you’ve partially forecasted its earnings for 2020-2022 (numbers are in millions).

	Actual earnings			Forecasted earnings
	2017	2018	2019	2020	2021	2022
Revenues	25,137	25,650	24,368	25,220	26,481	26,746
Cost of goods sold	18,375	17,894	19,750	21,230	20,381	19,973
Gross Profit	6,762	7,756	4,618	3,990	6,101	6,773
SG&A	2,235	2,110	2,050	2,200	2,200	2,200
Depreciation	2,000	2,000	2,000	2,000	2,000	2,000
EBIT
Tax expense (25%)
Net income

Assume that annual net working capital represents 10% of revenues. In 2021 Summit plans to purchase new equipment for its new generation of wind mills for $200 million. No other purchases are planned in 2020 or 2022.

Please enter the answer in the following format: XX,XXX

A. Calculate Summit's free cash flow in 2022.

B. Summit Energy’s beta is 1.7. Calculate its expected rate of return if the market portfolio return is 12% and the risk free rate is 4%

C. Calculate Summit’s terminal value if free cash flows are expected to grow 2% perpetually starting 2023. Use its expected rate of return from question B as a discount rate.

D. Calculate Summit’s NPV as of 2020. Use its expected rate of return from question B as a discount rate

Answer 1

Part (A)

Calculation of Free cashflow in 2022
Particulars	Amount ($)
Revenue	26746
Less:Cost of goods sold	19973
Gross profit	6773
SG$A	2200
Depreciation	2000
EBIT	2573
Less:Tax @25%	643.25
Profit after tax	1929.75
Add back depreciation	2000
Total cashflow	3929.75
Less:Working capital need(10% of revenue)	2674.6
TOTAL FREE CASHFLOW	1255.15

Part (B)

Expected rate of return
calculation formula is =Risk free rate +beta x(market rate-risk fre rate)
Risk free rate	4%
Market return	12%
Beta	1.7
Expected return = 4% + 1.7(12-4)%	17.60%

Part (C)

Calculation of terminal value for 2023
Last year free cashflow	1255.15
growth rate	2%
Discount rate	17.60%
Terminal value is calculated as follows
(1255.15x (1+2%))/17.6%-2%	$ 8206.75

Part (D)

Calculation of NPV
Year	2021	2021	2022
Revenue	-200	26481	26746
Less:Cost of goods sold		20381	19973
Gross profit		6100	6773
SG$A		2200	2200
Depreciation		2000	2000
EBIT		1900	2573
Less:Tax @25%		475	643.25
Profit after tax		1425	1929.75
Add back depreciation		2000	2000
Total cashflow		3425	3929.75
Less:Working capital need(10% of revenue)		2648.1	2674.6
TOTAL FREE CASHFLOW		776.9	1255.15
PVF @ 17.6%	1	0.85034	0.723078
Discounted cashflow	-200	660.6293	907.5718
NPV (660.63+907.5) -200	1368.2