Question

a. Calculate the free cash flow generated by a firm which has earnings before interest and taxes of £30m, has depreciated its fixed assets by £1m, has invested £10m in new fixed assets and £5m in working capital during 2019 when it paid corporate tax at 20%. Explain what you have assumed about the firm’s asset base.

b.During 2019 the firm in (a) generated revenue of £60m, its cost of goods sold was £20m and its selling, general and administrative costs were £10m. You anticipate that over the next five years revenue will grow at 5% each year, the cost of goods sold will continue to be a fixed percentage of revenue, but due to managerial efficiencies administrative costs will not change. All forms of investment, together with depreciation will have a consistent relationship with revenue.

At the end of this five year period you believe that free cash flow will grow at 2% each year. What is the company worth at the end of 2019, assuming that its weighted average cost of capital is 5%?

c.How would the company’s weighted average cost of capital and hence value change if it were to issue additional debt in order to repurchase equity?

d.Explain how you could value this company using multiples, and what assumptions you would have to make.

Answer 1

Given:

Tax = 20% or 0.20

How Free Cashflow is calculated:

Asset base Assumption:

1) Fixed Asset = 10 mil pounds (assuming that company is providing depreciation of 10% on its Fixed assets)

2) Total Net Working Capital Assumed:

Assumed EBIT margin 20% on turnover, therefore turnover is calculated to 150 mil pound

EBIT margin = 10%

3) Asset Turnover Ratio (ATR) assumed to 2 Times accordingly total assets is calculated as Turnover / ATR = 150 mil/2 = 75 mil

Therefore total asset-based of the company is assumed 75 mil pounds as above.