Long Term Financing
Activity 1:
Choose a publicly traded company on which to focus, modeled on the Walmart analysis in chapter 14.
Part A Project an income statement for next year for the firm based on your assessment of revenue growth, key projected financial ratios, and any other key assumptions, making sure to justify any assumptions.
- What is your projection for net income and how does it compare with the previous year?
- Based on your assessment of anticipated dividends, what is your projection for a change in retained earnings?
Part B Project a balance sheet for next year for the firm based on your assessment of the change in retained earnings, key projected financial ratios, and any other key assumptions, making sure to justify any assumptions. Use external borrowing as your balancing “plug.” What is your assessment of the firm’s financial needs?
Part C Based on your projection of financial needs, what recommendation would you make to the firm—for example, how to meet increased financing needs or what to do with excess financial capacity?
Activity 2: Creating Value
Free Cash Inc. is anticipated to make earnings before interest and taxes (EBIT) of $30,000, $40,000, and $50,000 in each of the next three years. Depreciation is estimated to be $3,000, $3,500, and $4,000 in each of the next three years. Capital expenditures are estimated to be $8,000, $9,000, and $10,000 in each of the next three years. Incremental increases in working capital requirements are estimated to be $2,500, $3,000, and $3,500 in each of the next three years. Free Cash Inc.’s tax rate is 35 percent.
Part A Estimate the free cash flows to the firm for Free Cash Inc. for each of the next three years.
Part B Free Cash Inc.’s cost of capital is estimated to be 9 percent. Free cash flows beyond year 3 are estimated to grow at an annual rate of 4 percent. Using this information and that provided in Part A, apply the growing perpetuity formula to estimate the terminal value of Free Cash Inc. as of year 3.
Part C Free Cash Inc.’s current value of existing debt is $58,996. Using this information and that provided in Parts A and B, estimate the value of the equity of Free Cash Inc. by applying the free cash flow to the firm method.
Part D Estimate Free Cash Inc.’s year 3 terminal value by applying an EV/EBITDA multiple of 8.5 times to year 3 EBITDA.