Question

Johnson Transformers Inc.

Following is the seven-year forecast for a new venture called Johnson Transformers: (all amounts in $000)

	2020	2021	2022	2023	2024	2025	2026
EBIT	$(1000)	$(900)	$200	$1,200	$2,500	$3000	$3,050
Capital Expenditures	$550	$350	$200	$175	$175	$160	$150
Changes in Working Capital	$400	$300	$200	$100	$100	($100)	($100)
Depreciation	$40	$80	$125	$150	$150	$150	$150

Beginning after year 2026 the annual growth in EBIT is expected to be 1.5%, a rate that is projected to be constant over Johnson Transformers remaining life as an enterprise.   Beginning in 2026 Johnson's Transformers capital expenditures and depreciation are expected to offset each other (capex - depreciation = 0) and year to year changes in working capital are expected to be zero (working capital levels remain constant year over year). For discounting purposes consider 2020 as year 1.

Assume a tax rate is 21% and a cost of capital of 7.75%

Question 1: Determine the NPV of Johnson Transformers Free Cash Flow for the years 2020 -2026. HINT: Remember to account for loss carry-forwards when determining income taxes. The answer to this question was determined in Excel. Your answer may deviate slightly depending upon differences in truncation and rounding. Answers below are in $000.

Answer: $2105

Calculate the fair market value (NPV) for Johnson Transformers. For this problem assume that the Net Present Value of Johnson Transformers free cash flow for the period 2020 - 2026 is $3000 (NOTE its not $3000 but make this assumption in case the answer you determined in the first question was incorrect. Assume no underlying changes to any of the data in the problem. DO NOT USE YOUR ANSWER FROM THE QUESTION ABOVE. All ANSWERS ARE IN $000

$26,206

$22,089

$24,536

$21,830

$34,476

Answer 1

First, we calculate the net operating cash flow for each year

net operating cash flow = EBIT - capex - change in working capital + depreciation - tax outgo

In the first two years, the accumulated losses are 1000 + 900 = 1900. This is carried forward to the future years and set off against the EBIT of those years until the accumulated losses are completely set off. In year 3 and year 4, the EBIT is completely set off , and the tax outgo is zero. In year 5, the accumulated losses remaining are 1900 - 200 - 1200 = 500. In year 5 the EBIT is 2500. therefore tax outgo = (2500 - 500) * 21% = 420. In years 6 and 7 tax outgo = EBIT * 21%

Next we compute the Present value factor for each year using the 7.75% discount rate. PVF = 1 / (1 + 0.0775)^year

Present value of each cash flow = Net cash flow * PVF

The sum of these PVs is the NPV of the cash flows

NPV = 2,105

Next, we compute the value of Johnson Transformers at the end of 2026 using the constant growth formula.

Value of constant growth cash flow = (cashflow at end of next year) / (required rate of return - constant growth rate)

value at end of 2026 = (2510 + 1.5%) / 7.75% - 1.5%

value at end of 2026 = 40,754

now we discount this back to the present. present value = 40,754 / (1+ 7.5%)^7 = 24,169

Fair market value of Johnson Transformers = present value of cashflows + present value of value at end of 2026

Fair market value of Johnson Transformers = 2,105 + 24,169 = 26,274