Question

Use this information to answer the questions on the quiz. Additional information will be provided as the quiz proceeds. Gemco Jewelers earned $5 million in after-tax operating income in the most recent year. The firm also had capital expenditures of $4 million and depreciation of $2 million during the year and the non-cash working capital at the end of the year was $10 million. The company's WACC =12%

1.Estimate next year's after tax operating income.

2.Using the information in question 1, find the change in Net Working Capital (NWC) (from year 0 to year 1).

3.Using the information from question 1, find the FCF in year 1. Note, FCF = EBIT(1-T) +D -CAPEX+change in (NWC), If the firm can grow at 20% for one more year estimate the FCF for year 2. Find the Present Value of the cash flows in years 1 and WACC = 12%

4.After year 2, the firm's capital expenditures will decline to 25% of after-tax operating income and the growth rate will drop to 5% (for both operating income, depreciation and non-cash NWC) Find the after tax operating income. Find the company's total investment in NWC in year 2. Find the FCF for year 3

Answer 1

Solution 1. After tax operating Income of next year = After tax operating Income + Depreciation

ATOI = $5 + $2 = $7 million

Solution 2. Change in net working capital = $10 million

Solution 3. FCFF in year 1 = earning after tax x growth rate - CAPEX x Growth Rate - ((WC x Growth rate) - WC)

=5*(1+20%)- (4-2)*(1+20%)- (10*(1+20%)-10)

= $1.60 million

FCFF in year 2 = 5*(1.20)*(1.20) -(4-2)*(1.2)*(1.2) - (10*(1.2)*(1.2)-10*1.2)

= $1.92 million

Present Value = FCFF/(1+WACC)^n

where n is no. of years

Present value of FCFF in year 1 = 1.60/(1+0.12)^1

= $1.43 million

Solution 4. after 2 years FCFF is $1.92 (from solution 3 above)

After tax operating income in year 3 = 5*1.20*1.20*1.05 = $7.56 million

Total investment in NWC in year 2 = 10*1.2*1.2 = $14.40

FCFF for year 3 = 7.56 - (4-2)*1.2*1.2*1.05 - (10*1.2*1.2*1.05-10*1.2*1.2)

= 7.56- 3.024- 0.72

= $3.816 million