Question

Table 1 - Hampton Tool Company ($ in thousands) Growth to Infinity 1999 2000 2001 2002 2003 Sales Cash Cost of Goods Depreciation Selling and Admin EBIT Tax @ 35% EBIAT (+) Depreciation Cash Flow Operations $61,000 29,890 4,000 21.010 6,100 2.135 3,965 4,000 7,965 63,440 30,768 4,160 21.570 6,942 2,430 4,512 4,160 8,672 65,978 31,669 4,326 22.103 7,880 2.758 5,122 4,326 ,448 68,617 32,593 4,499 22,232 9,293 3,253 6,040 4,499 10,539 71,361 33,896 4,679 22,407 10,379 3,633 6,746 4,679 11,425 + 4% +4% +4% +4% +4% +4% +4% +4% +4% 9 Sales growth would require a corresponding buildup of spontaneous net working capital (accounts receivable + inventories - accounts payable - accrued expenses) and capital expenditures in excess of the annual depreciation expense (See Table 2.) Table 2 - Hampton Tool Company ($ in thousands) 1999 2000 2001 2002 2003 Growth to Infinity J $13,420 $13,957 $14,515 $15,096 $15,700 + 4% Spontaneous net working capital (Investment) in net working capital J (516) (537) (558) (581) (604) +4% Capital expenditures 4,938 5,136 5,341 5,555 5,777 +4% Management of Lycos, Inc. used discounted cash flow analyses to value mature acquisition targets. As of late-1998, with inflation stable at a 2% annual rate, management believed that a 10% discount rate was appropriate in valuing acquisitions in the hand tool business. What is the maximum price that Lycos should be willing to pay?

Answer 1

Please see the table below. Please be guided by the second column titled “Linkage” to understand the mathematics. The last row highlighted in yellow is your answer. Figures in parenthesis, if any, mean negative values. All financials are in $ '000. Adjacent cells in blue contain the formula in excel I have used to get the final output.

Year count, n		1	2	3	4	5	6
Year	Linkage	1999	2000	2001	2002	2003	2004	How the value for 2004 has been calculated?
Cash flow operations	A	7,965	8,672	9,448	10,539	11,425	11,882	11425 x (1 + 4%)
Investment in working capital	B	(516)	(537)	(558)	(581)	(604)	(628)	-604 x (1 + 4%)
Capital expenditure	C	(4,938)	(5,136)	(5,341)	(5,555)	(5,777)	(6,008)	-5777 x (1 + 4%)
FCFF	D = A + B + C	2,511	2,999	3,549	4,403	5,044	5,246	5044 x (1 + 4%)
Terminal growth rate	g						4.0%
Real Discount rate	E	10.00%
Inflation	F	2.00%
Nominal discount rate	r = (1 + E) / (1 + F) - 1	7.84%
Terminal value	TV = FCFF of 2004 /(r - g)					136,497
Discount factor	DF = (1 + r)^(-n)	0.9273	0.8598	0.7973	0.7393	0.6855
PV of FCFF	D x DF	2,328	2,579	2,830	3,255	3,458
PV of terminal value	TV x DF of 2003					93,575
Maximum Price	Sum of all PV of FCFF + PV of Terminal Value	108,025