Classnote 23 2012
Check the 6 minute video:
Class 23 (today), final compulsory class, finish DCF from Classnote 22, wrap-up Q’s,
review, exam discussion, Q&A, goodbye, course evaluations.
Big Q&A ‘amphi office hour’ session, 1pm-3pm, Weds 4 April
Final Exam, 10 April, 2 ½ hours, usual format
1 Q (Dec2010, final exam)
It is December 2010. You are the 100% owner of Holy Scrap Breakfast Corp. (HSBC). The firm’s bank
debt is currently $50,000 and carries a 8%p.a. fixed interest rate. In the absence of further investment,
you believe a reasonable trailing twelve months (ttm) TEV/EBITDA multiple for your firm is 9.
The most recent Earnings before interest and tax was $90,000. The corporate tax rate is 40%.
Depreciation last year was $20,000. Expenditures on machinery were $40,000. Net working capital is
Pizzaman is willing to invest $100, 000 into Holy Scrap Breakfast Corp. (HSBC) now in return for 20% of
the firm’s equity. With this, and an additional bank loan of $40,000 drawn down now (carrying a fixed
interest rate of 8%p.a. paid annually, in arrears) and all invested now in productive fixed assets, you
believe the recapitalized HSBC could achieve the following results (assume all the following cashflows
occur at the end of their respective calendar year):
By the end of 2011, net working capital will be $100,000. The existing machines will be sold at the end of
2011 for their net book value of $25,000 and immediately replaced by new machines costing $85,000. At
this time an additional borrowing of $60,000 will be undertaken to finance these machines. Depreciation
will be $35,000 in 2011 and the year’s Earnings Before Interest and Taxes will be $200,000.
In 2012 net capital expenditures will be equivalent to the depreciation charge for the year and net
working capital will be $90,000. The year’s Earnings Before Interest and Taxes will be $280,000.
Free cashflows to the firm will grow by 20% in the year to 2013 and by 2%p.a. in all subsequent years.
An appropriate weighted average cost of capital is estimated to be 14%p.a.
2 a) What is the value of your equity stake in HSBC if there is no new investment? (3 marks)
• Find the EBITDA, which should be 110K
• The EBITDA is a quick measure of cash flow before the final profit number is calculated
• The TEV/EBITDA ratio measures the value of the firm to its cash flow, so if it’s 9 times (like
in this example), it says the market is willing to pay 9 times its cash flows.
• TEV here is 990K
• To get equity value, you subtract the 50K of debt, this will give you the answer of 940 equity.
b) What is the value of your equity stake in HSBC if the new investment goes ahead? (13 marks)
• The idea of FFCF is that we can estimate free cash flows of the future.
• These cashflows belong to all security holders of the firm.
• Discounting the free cash flows via FCFF will give us TEV, thus it is ALL securities.
• We’re looking for future cash flows.
• Draw timelines for questions like this.
• Today is when we’re valuing the firm.
• For 2011, first use the EBITx(1-T), giving us 120K + 35K(which is the depreciation) –
60K(which is the NET capital expenditure) - the increase in working capital of 35 = FCFF
• FFCF measures value available to security holders
• FFCF ignores the financing
• So now we have to do FFCF of year 2.
• The calculation is 280*0.6=168; the Dep and NetCap net out to 0.
• The answer should be 178K
• For the year 3, its 213.6
• The next cash flow is 2% higher, so 217.9
• All the rest are going up by 2%
3 • NOW we need to DISCOUNT them
• At the discount rate of WACC which is 14%
• Take each amount and divide it by 1.14to the power of the year.
• Y1 is 52.6
• Next year is 137K
• You can do these one by one or can use D /(r1g)
• D would be 217.9?, r is the WACC and g is the growth rate 2%
• Answer should be 1815
• This is Year 4 to infinity valued at year 3
• 1815 x (1/1.4 ) = 1225
• You can also value at growing perpetuity at year 2 (using the D at 3 and on forever), which
will give you 1780, and then the stuff before giving you 1369
• FINAL answer should be 1559, this is the TEV
• So you determine future cash flows, discount them at the WACC, and that’s your TEV.
• So the 1559 is the TEV of the firm as of now, Dec 2010.
• To get the equity, we subtract the debt portion, the 50K, as well as take out the new debt, the
• 1469 is our estimate of the value of equity.
• Out of this amount, 20% belongs to the Pizza guy and 80% to the entrepreneur
• So it’ll be 294 for the pizza guy and 1175 is ours.