Adjusted Present Value Valuation The Joel Germunder Company: The Joel

Germunder Company (Germunder) is a privately held family business that currently

uses no debt in its capital structure. The owner-managers have a plan to expand the

operations of the company over the next two years. Some of Germunders younger

owner-managers proposed a plan to issue a large amount of debt to not only expand the

companys operations but to also pay the owners a one-time, special dividend. The

younger owner-managers plan is to finance the entire transaction by issuing $15 million

of 10% debt.After the company completes its expansion, the plan of the younger owner-managers is to use some of the free cash flows to repay the debt until the end of Year 3, but they will continue to pay some dividends in Years 1 through 3. As of the beginning of Year 4, they expect the companys cash flows to grow at the long-run inflation rate, which they expect to be 2.5%. At the end of Year 3, they believe that the company will have paid down a sufficient amount of debt so that the remaining debt will be used as the basis of a stable target capital structure, and the debt will grow at the overall growth rate of 2.5%. While the leverage of the company will decline some over the first three years, it will not fall enough to change the cost of debt. Moreover, since the debt-to-value ratio will stay the same after Year 3, the cost of debt will remain at 10%. The company does not hold any excess cash, and all equity free cash flows will be paid out as a dividend to shareholders. The companys chief financial officer prepared a set of financial forecasts that reflects this plan. The income statement, balance sheet, and cash flow statement forecasts appear in Exhibit P5.1. The forecasts assume the company will issue the debt at the end of Year 0, which is reflected in the balance sheet for that year. Germunders income tax rate for all revenues and expenses (including interest) is 40%, and its unlevered cost of capital is 12%. a. Use the financial statements in the exhibit to measure Germunders unlevered free cash flows in Years 1 through 4.

b. Value Germunder the entire firm and equity as of the end of Year 0 using the APV valuation method. Assume that the appropriate discount rate for interest tax shields is the unlevered cost of capital of the company.