Question

1. You have married into a family business and you are in charge of the finances. Your father-in-law is considering an IPO and has asked you to come up with estimates for the equity value. Here are the figures you have been able to come up with so far: (12 pt.s) a) 2020 free cash flow: $9.0MM b) 2021 free cash flow: $9.8MM c) 2022 free cash flow: $10.5MM d) Annual FCF growth after 2022: 4% e) 2020 EBITDA: $9.5MM f) 2020 earnings: $6.0MM g) Company WACC (discount rate): 12% h) Total debt: $6MM i) 2020 accounts payable: $4MM j) Overall PE ratio in the stock market: 16x k) Overall PE ratio for similar companies: 20x l) EV / EBITDA multiple that similar companies have sold for: 10x Please develop an equity valuation for the business using the free cash flow valuation method. Please also provide two additional equity valuations, using other methods. Which method do you think is best to use in this case? Why?

Answer 1

Terminal Value (TV) at Year 2022 = Free cash flow in 2022 x (1+g) / WACC - g

TV 2022 = 10.5*1.04 / 0.12-0.04 = 136.5

Now we will calculte the present value of all the cash flows to calculate value of the firm

Year	Particulars	Amount	PV @ 12%
2020	FCF	9	8.04
2021	FCF	9.8	7.81
2022	FCF	10.5	7.47
2022	TV	136.5	97.16
	Value of Firm		120.48

Value of Equity = Value of firm - Value of debt

Value of Equity = 120.48 - 6

Value of Equity = 114.48

Two Other Valuation Estimate

1. Using PE Ratio

Value of Equity = 2020 Earnings x PE ratio of similar companies

Value of Equity = 6 x 20 = 120

2. Using EV / EBITDA

Value of Firm = EBITDA x EV/EBITDA Multipe

Value of Firm = 9.5 x 10 = 95

Value of Equity = Value of Firm - Value of Debt

Value of Equity = 95 - 6 = 89