Question

LG

Following is the seven-year forecast for LG: (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 LG remaining life as an enterprise.   Beginning in 2026 LG 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%

Calculate the fair market value (NPV) for LG. Assume that the Net Present Value of LG free cash flow for the period 2020 - 2026 is $3000

Answer 1

A	B	C	D	E	F	G	H	I	J
2
3		Fair market value will be sum of NPV for period 2020-2026 and NPV for 2027 onwards i.e.
4		Fair market value	=NPV for period 2020-2026+NPV for 2027 onward.
5
6		NPV for period 2020-2026	$3,000
7
8		Calculation of NPV for 2027 onward:
9		To calculate NPV, IRR and Payback Period of the project, free cash flow needs to be calculated as follows:
10		Free Cash Flow = EBIT*(1-Tax Rate)+Depreciation - Capital Expenditures - Change in working capital
11
12		Tax Rate	21%
13
14		After 2026,
15		EBIT growth rate	1.50%
16		Depreciation - Capex	0
17		Change in Net Working capital	0
18
19			2026	2027	2028	…
20		EBIT	$3,050	$3,096	$3,142	$3,189
21		EBIT*(1-Tax Rate)	$2,410	$2,446	$2,482	$2,520
22		Free Cash Flow	$2,410	$2,446	$2,482	$2,520
23		Growth rate of FCF		1.50%	1.50%	1.50%
24
25		Cost of capital (r)	7.75%
26		Terminal growth rate (g)	1.50%
27		PV of FCF after 2027 at 2026	=Present value of growing perpetuity
28			=FCF2027 / (r-g)
29			=$2446 / (7.75% - 1.5%)
30			$39,130.28
31
32
33		Fair market value	=NPV for period 2020-2026+NPV for 2027 onward.
34			=$3,000+$39,130.28
35			$42,130.28	=D6+D30
36
37		Hence fair market value will be	$42,130.28
38

Formula sheet