Question

Company A is preparing a cash flow forecast for a potential acquisition target, Company B. You have been asked to estimate FCF (free cash flow) for the next three years based on the following assumptions: o For the last full year (which has just ended), revenues were $125M. Revenue growth is expected to be 15%, 12% and 10%, respectively in the next three years. o Operating margin was 40% last year, this margin is expected to continue for the next three years. o Taxes are expected to be at 20% over the next three years. o The current assets of the business are simple: Cash can be assumed as zero. Most sales are to other businesses; the company offers good credit terms and trade accounts receivable at each year end represent 20 days of annual sales. Inventory turn (measured on the basis of revenue) is 10x at year end o The only fixed assets of the business are PP&E. The PP&E turn for the business (measured on the basis of revenue) is 1.6x at year end. o The company has only one liability – accounts payable and accruals – at end of year these accounts are approximately 5% of sales. There is no debt.

Estimate FCF for the next three years given these facts.

Answer 1

[Dollars in millions]	0	1	2	3
Revenues	125.00	143.75	161.00	177.10
NOI at 40%		57.50	64.40	70.84
Taxes at 20%		11.50	12.88	14.17
NOPAT [1]		46.00	51.52	56.67
NWC:
Receivables (Revenue*20/365)	6.85	7.88	8.82	9.70
Inventory (Revenue/10)	12.50	14.38	16.10	17.71
Payables and accruals (5% of sales)	6.25	7.19	8.05	8.86
NWC	13.10	15.06	16.87	18.56
Change in NWC [2]		1.96	1.81	1.69
PP&E:
At year end (Revenue/1.6)	78.13	89.84	100.63	110.69
Capital expenditure [3]		11.72	10.78	10.06
FCF = [1] - [2] - [3]		32.32	38.93	44.92