Question

Greshak Company, Inc. is in the business of producing and marketing high-tech widgets. Assume you are a financial analyst at Greshak and have been charged with the task of estimating the value (i.e., intrinsic value) of the company's outstanding common stock at December 31, 2017. As part of that analysis, management has provided you with the company's most recent income statement and balance sheet for 2017 as well as financial projections of each for the next 4 years.  

Assume Greshak's applicable tax rate is 40% and that management has determined its weighted average cost of capital (WACC or “discount rate”) to be 14.0%. Further, assume Greshak has estimated its long-term sustainable growth rate (g) for its free cash flows (FCF) to be 3% upon reaching earnings stabilization after 2021 (the last year in the projection period).  

Required: Based on the above (and given the financial projections below):

Calculate Greshak’s projected Free Cash Flow (FCF) for 2018 through 2021 using MS-Excel and the template on the following page. Assume that year-over-year changes in projected operating current assets and operating current liabilities represent the inputs for calculating projected annual investments in net operating working capital. Assume the projected year-over-year change in gross fixed assets represents capital expenditures for that year.  

Calculate the Intrinsic Value of Greshak’s operations (i.e., the estimated value of the company) using the data. also need: Value of operations or 100% of company, Value of common equity, Price per share, Book value per share, and Price-to-book ratio.

actual	Projected
2017	2018	2019	2020	2021
Net sales	1,050	1,275	1,475	1650	1735
COGS	568	680	785	900	982
rent	80	100.5	118	128	135
salaries	125	157	195	222	235
depreciation	42	59	48	45	45
Interest expense	24	22.5	24	20	21
other	132	159	195	197	170
Total expenses	971	1178	1365	1512	1588
Pre-tax income	79	97	110	138	147
Taxes (40%)	31.6	38.8	44	55.2	58.8
Net income actual	47.4	58.2	66	82.8	88.2

Balance sheet at December 31, in millions of USD

	actual	projected
	2017	2018	2019	2020	202125
Cash	25	40	45	50	62
Account receivables	125	125	142	168	180
Inventories	285	295	305	312	322
Total current assets	435	460	492	530	564
Gross fixed assets	600	690	765	830	900
Less: accumulated depreciation	328	387	435	480	525
Net plant and equipment	272	303	330	350	375
Total assets	707	763	822	880	939
Account payable	60	70	82	85.8	105
Notes payables	80	70	71	70	75
Accruals	66	80	92	105	110
Total current liabilities	206	220	245	260.8	290.0
Long term bonds	161	195	200	237	258
Total liabilities	367	415	445	497.8	548
Common stock (12,000,000 shares)	160	160	160	160	160
Retained earnings	180	188	217	222.2	231
Total common equity	340	348	377	382.2	391
Total liabilities and equity	707	763	822	880	939

Answer 1

All financials below are in $ mn

Nos. of shares is in mn

Per share price is in $ / share

Please see the table below. In the first part i have reproduced the Income statement and Balance Sheet. After that our calculations start. Please pay attention to the linkage column, Note and Note 2. That will help you understand how each row has been calculated. This will also help you develop your own excel file, if need be.

Parameter	Linkage	actual	Projected
Year		2017	2018	2019	2020	2021
Net sales	A	1,050	1,275	1,475	1650	1735
COGS	B	568	680	785	900	982
rent	C	80	100.5	118	128	135
salaries	D	125	157	195	222	235
depreciation	E	42	59	48	45	45
Interest expense		24	22.5	24	20	21
other		132	159	195	197	170
Total expenses		971	1178	1365	1512	1588
Pre-tax income		79	97	110	138	147
Taxes (40%)		31.6	38.8	44	55.2	58.8
Net income actual		47.4	58.2	66	82.8	88.2
Balance sheet at December 31, in millions of USD
		actual	Projected
		2017	2018	2019	2020	2021
Cash		25	40	45	50	62
Account receivables	F	125	125	142	168	180
Inventories	G	285	295	305	312	322
Total current assets		435	460	492	530	564
Gross fixed assets		600	690	765	830	900
Less: accumulated depreciation		328	387	435	480	525
Net plant and equipment		272	303	330	350	375
Total assets		707	763	822	880	939
Account payable	H	60	70	82	85.8	105
Notes payables		80	70	71	70	75
Accruals	I	66	80	92	105	110
Total current liabilities		206	220	245	260.8	290
Long term bonds		161	195	200	237	258
Total liabilities		367	415	445	497.8	548
Common stock (12,000,000 shares)		160	160	160	160	160
Retained earnings		180	188	217	222.2	231
Total common equity		340	348	377	382.2	391
Total liabilities and equity		707	763	822	880	939
OUR CALCULATION
Year No.	Linkage	0	1	2	3	4
EBIT	A-B-C-D-E		278.50	329.00	355.00	338.00
Tax rate, T			40%	40%	40%	40%
Operating current assets	F+G	410.00	420.00	447.00	480.00	502.00
{-] Operating Current Liabilities	H+I	126.00	150.00	174.00	190.80	215.00
Net operating working capital		284.00	270.00	273.00	289.20	287.00
Investment in working capital (Note 1 below)	J		(14.00)	3.00	16.20	(2.20)
Note 1: Calculated as difference of net operating working capital of successive years			=284-270	=273-270	=289.2-273	=287-289.2
Investment in fixed assets (Note 2 below)	K		90.00	75.00	65.00	70.00
Note 2: calculated as difference of gross fixed assets of successive years			=690-600	=765-690	=830-765	=900-830
Free Cash flow to the Firm (FCFF) Calculation
EBIT x (1 - T)			167.10	197.40	213.00	202.80
[+] Depreciation	E		59.00	48.00	45.00	45.00
[-] Investment in working capital	J		(14.00)	3.00	16.20	(2.20)
[-] Investment in fixed assets	K		90.00	75.00	65.00	70.00
Free Cash flow to the firm, FCFF			150.10	167.40	176.80	180.00

WACC, discount rate = r = 14%

Sustainable long term growth rate, g = 3%

We now need to calculate the horizon value of the FCF at the end of 2021 = HV_{FCF, 2021} = FCFF₂₀₂₁ x (1 + g) / (r - g) = 180 x (1 + 3%) / (14% - 3%) = 1,685.45

Hence, Value of the operating assets of the firm = Value of Greshak’s operations = Present value of all the FCFF + Present value of horizon value of FCFF

= 1,484.31

Value of non operating asset = Value of cash at the end of 2017 = 25

Hence, value of the firm = Value of operations + value of non operating assets = 1,484.31 + 25 =  1,509.31

Value of liabilities = Notes payable + Long term bonds at the end of 2017 = 80 + 161 = 241

Value of common equity = Value of firm - value of liabilities = 1,509.31 - 241 =  1,268.31

Nos. of shares, N = 12 mn shares

Price per share = Value of common equity / N = 1,268.31 / 12 = $ 105.69 / share

Book value per share = Balance sheet value of common equity at the end of 2017 / N = 340 / 12 = $  28.33 per share

and Price-to-book ratio = Price per share / Book value per share = 105.69 / 28.33 =  3.73