Question

We find the following information on NPNG (No-Pain-No-Gain) Inc. (18 marks total)

EBIT = $2,000,000

Depreciation = $250,000

Change in net working capital = $100,000

Net capital spending = $300,000

These numbers are projected to increase at the following super normal rates for the next three years, and 5% after the third year for the foreseeable future:

EBIT: 10%

Depreciation: 15%

Change in net working capital: 20%

Net capital spending: 15%

The firm’s tax rate is 35%, and it has 1,000,000 outstanding shares and $6,000,000 in debt. We have estimated the WACC to be 15%.

a.

Calculate the EBIT, Depreciation, Changes in NWC, and Net Capital Spending for the next four years. (8 marks)

b.

Calculate the CFA* for each of the next four years, using the following formula : CFA* = EBIT(1–T) + Depr – ΔNWC – NCS   (4 marks)

d.

Calculate the present value of growing perpetuity at Year 3.

(1 mark)

e.

Calculate the firm’s value at time 0 using the WACC of the firm as the discount rate. (Note that the first CFA* to be discounted is the cash flow from one year into the future.)

(3 marks)

f.

Calculate the firm’s equity value at time 0.

(1 mark)

g.

Calculate the firm’s share price at time 0

Answer 1

Answer:

A)

Sample Calculation

For year 2

EBIT=EBIT in previous year*(1+10%)=2000000*(1+10%)=$2200000

Depreciation =Depreciation in previous year*(1+15%)=250000*(1+15%)=$287500

NWC= NWC in previous year*(1+20%)=100000*(1+20%)=$120000

Net Capital = Net Capital in previous year*(1+15%)=300000*(1+15%)=$345000

Year	1	2	3	4
EBIT	2000000	2200000	2420000	2541000
Depreciation	250000	287500	330625	347156.25
NWC	100000	120000	144000	151200
Net Capital	300000	345000	396750	416587.5

B)

Year	1	2	3	4
EBIT	2000000	2200000	2420000	2541000
Depreciation	250000	287500	330625	347156.25
NWC	100000	120000	144000	151200
Net Capital	300000	345000	396750	416587.5
EBIT*(1-T)	1300000	1430000	1573000	1651650
CFA	1150000	1252500	1362875	1431018.75

D.

CF4=1431018.75

g=5%

r=15%

So PV at end of third year CFP3= CF1/(r-g)=1431018.75/(15%-5%)=$14310187.5

E.

Firm's PV at Year 0= CFA1/(1+15%)+CFA2/(1+15%)^2+CFA3/(1+15%)^3+CFP3/(1+15%)^3

Firm's PV at Year 0=1150000/(1+15%)+1252500/(1+15%)^2+1362875/(1+15%)^3+14310187.5/(1+15%)^3=$12252362.95

F.

Firm's Equity value at Time zero= PV of firm - Debt=12252362.95-6000000=$6252362.95

G. Firm share price= Firm's equity value / Outstanding shares=6252362.95/1000000=$6.25 per share