Free Cash Flow (2011-2013) – Question 1
Question 1 asks for the calculation of the free cash flow for the operations of FinchCo for the years 2011, 2012 and 2013 only. The calculations for the free cash flows for these three respective years can be found in the excel spreadsheet. The free cash flows have been restricted to only these three years because it is the requirement of the question. Furthermore, there is no mention of terminal value and the case does not provide any terminal growth rate therefore, it has been ignored.
The free cash flows of the company have been calculated by taking the profit before interest and taxes which are shown in exhibit 3 of the case. These are all projected. The average tax rate as provided in the case is 30% and tax has been then deducted from the operating income in order to calculate the net operating profit after tax for the company for all the three years. $5000 is the depreciation expense for each of the year which has been then added back. The reason for this is that depreciation is a non-cash expense therefore, it has been added back. The adjusted operating cash flows have been arrived in this way.
Moreover, the working capital to sales ratio has been calculated for the year 2010, as this is the assumption which has been stated by Ms. Bhathal in order to calculate the working capital requirements for all the future years. The working capital to sales ratio has been calculated to be around 13.81%. Based upon this rate, the working capital requirement has been calculated for each of the year and then by taking the differences the incremental working capital has been calculated. The requirements for the investment in the capital expenditure are equal to depreciation which has also been deducted. In this way, the free cash flows for each of the three years have been calculated.
Cost of Equity – Question 2
The cost of equity for FinchCo has been used through the capital asset pricing mode. The illiquidity premium of 6% has been taken as the market premium here which has been mentioned in the case. The risk free rate is also provided in exhibit 4 which is around 0.94%. The one and only comparable company to FinchCo whose data has been provided is Toromont Industries and its beta of 0.8 has been used.
The above beta is basically an asset beta and it has not been un-geared. This is because; Toromont Industries has zero debt in its capital structure. The target capital structure for the company has also been suggested by Ms. Bhathal, which is around 40% dent to value ratio. This has been used to re-gear the beta for the company. Furthermore, the capital asset pricing model has been used to calculate the value of the cost of equity which is around 8.94%.
Since the capital structure of FinchCo comprises of debt also and the after tax cost of debt for the company has also been provided therefore, based upon the target capital structure the weighted average cost of capital for the company has also been calculated which is around 6.37%.
Enterprise Value of FinchCo – Question 3
Taking the free cash flows for the three year period that have been calculated in question 1 and the weighted average cost of capital for the company of 6.37%, the present value of the free cash flows of the company has been calculated. The present value of the free cash flows for the company is $ 4240.
FinchCo had also established one of its subsidiaries, which operated in the retail sector and the name of this property is Finch Properties. The investment of this subsidiary was shown in the books of the company as an investment in properties. On the other hand, the accounts of both the companies and their financial statement were not consolidated at all and they were valued separately. Therefore, in order to identify the true enterprise value of FinchCo, the value of its subsidiary should also be added.
Finch Properties owned the real state for the company and the value of this property was determined by the analysts to be $ 15800 recently. Therefore, this value has then been added in the present value of the free cash flows and the total enterprise value for FinchCo is $ 20040................
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