Question

Help with #6?

6. (Equity Valuation Cash Flows] Following are financial statements (historical and forecasted) for the Global Products Corporation. GLOBAL PRODUCTS CORPORATION BALANCE SHEETS 2016 FORECAST 2017 Cash $ 50,000 $ 60,000 Accounts receivable 200,000 290,000 Inventories 450,000 570,000 Total current assets 700,000 920,000 Fixed assets, net 300,000 380,000 Total assets $1,000,000 $1,300,000 Accounts payable 140,000 180,000 Accruals 50,000 70,000 Bank loan 80,000 90,000 co Total current liabilities 270,000 340,000 Long-term debt 400,000 550,000 Common stock ($1 par value) 50,000 50,000 Capital surplus 200,000 200,000 Retained earnings 80,000 160,000 Total liabilities and equity $1.000.000 $1,300,000 INCOME STATEMENTS FORECAST 2017 Net sales Cost of goods sold Gross profit Marketing General and administrative Depreciation Earnings before interest and taxes Interest Earnings before taxes Income taxes (40% rate) Net income $1,300,000 780,000 520,000 130,000 150,000 40,000 200,000 45,000 155,000 62,000 $ 93,000 $1,600,000 960,000 640,000 160,000 150,000 55,000 275,000 55,000 220,000 88,000 $ 132,000 A. Assume that the cash account includes only required cash. Determine the dollar amount of equity valuation cash flow for 2017. B. Now assume that Global Products' required cash is set at 3 percent of sales. Any additional cash would be surplus cash. Re-estimate the dollar amount of equity valuation cash flow for 2017.

Answer 1

Answer –

Part 1 – Assume that the cash account includes only required cash. Determine the dollar amount of equity valuation cash flow for 2017

Equity Valuation Cash Flow =Net Income: $132,000+ Depreciation: $55,000

LESS : Change in NOWC: [($60,000 + $290,000 + $570,000 - $180,000 - $70,000) – ($50,000 + $200,000 + $450,000 - $140,000 - $50,000)] = $670,000 - $510,000 = $160,000

LESS : Change in Gross Fixed Assets: ($380,000 - $300,000 + depreciation of $55,000) = $135,000

ADD : Net Debt Issues: ($90,000 + $550,000) – ($80,000 + $400,000) = $640,000 - $480,000 = $160,000

Equity Valuation Cash Flow = $132,000 + $55,000 - $160,000 - $135,000 + $160,000= $52,000

Part 2 –

Now assume that Global Product’s required cash is set at 3 percent of sales. Any additional cash would be surplus cash. Re-estimate the dollar amount of equity valuation cash flow for 2017.

Required Cash: 2016 = $1,300,000 x .03 = $39,000

Surplus Cash: $50,000 - $39,000 = $11,000

Required Cash: 2017 = $1,600,000 x .03 = $48,000

Surplus Cash: $60,000 - $48,000 = $12,000

Change in NOWC (without surplus cash): [($48,000 + 290,000 + $570,000 - $180,000 - $70,000) – ($39,000 + $200,000 + $450,000 - $140,000 - $50,000)] = $658,000 - $499,000 = $159,000

Equity Valuation Cash Flow = $132,000 + $55,000 - $159,000 - $135,000 + $160,000 = $53,000.

The 2017 stripping of the additional $1000 of surplus cash leads directly to a $1000 increase in the valuation cash flow.

Part 3 –

Let’s assume that investors in Global Products want to estimate the venture’s present value at the end of 2016. Forecasted financial statements reflect the stepping stone year. Cash flows are expected to grow at a perpetual 8 percent annual rate beginning in 2018. Assume that all cash is required cash as was done in Part A. What is the Global Products venture’s present value if investors want an annual rate of return of 25 percent?

Present Value @ 25% = $52,000/(.25 - .08) = $305,882.35

Part 4-

Work with the assumptions in Part B about Global Products required cash being 3 percent of sales. Calculate the present value of the Global Products venture at the end of 2016 if investors want an annual rate of return of 25 percent and cash flows are expected to grow at a perpetual 8 percent annual rate beginning in 2018.

Present Value @ 25% = $53,000/(.25 - .08) = $311,764.71