Question

Rumour has it that Apex Industries is interested in buying your company’s solar panel manufacturing operation. Your company is willing to sell if it can get the full value of this rapidly growing business.
The problem is figuring out what the present value is.
Brief projected financials for the venture are shown in Table 1 below.

a) The free cash flows for the manufacturing operation are projected to be negative for the first six years. Critically discuss why this may be a good or bad thing.

	Year
	1	2	3	4	5	6	7	8	9	10
	(Millions of Dollars)
Asset Value	10.00	12.00	14.40	17.28	20.74	23.43	26.48	28.07	29.75	31.54
Earnings	1.20	1.44	1.73	2.07	2.49	2.81	3.18	3.37	3.57	3.78
Investment	2.00	2.40	2.88	3.46	2.70	3.05	1.59	1.68	1.79	1.89
Free Cash Flow	-0.80	-0.96	-1.15	-1.38	-0.21	-0.23	1.59	1.68	1.79	1.89
Earning growth from previous period	20%	20%	20%	20%	20%	13%	13%	6%	6%	6%

Answer 1

Negative cash flows are not always bad if it is for a temporary period. During the start of a business, a company generally has negative cash flows due to ramping up the productions and other investments. Till the time, rate of return on capital is more than the cost of capital; it is fine to have negative cash flows.

In this case, we can observe that the company's earning has increased constantly during the given time period. Moreover, it is also evident from the given information, that the company has increased its investment from time period 1 to time period 4 and then decreased it after that. This can be one of the reasons for the cash flows to become negative during this time period.