As the newly appointed CFO of an established firm, your CEO brings to you a proposal to acquire a rising

competitor that would make your firm the largest player in the market. In order to make a competitive offer, the

CEO has asked you to come up with a value for the target firm. As the firm does not pay dividends, you elect

to use the free cash ow (FCF) model of valuation.Currently, the target firm has a single outstanding debt issue

quoted at $95.823 per bond with 2,500 bonds outstanding. The target firm also has 15,000 shares of preferred

stock outstanding with a market value of $10/share.You obtain the following three years of information from the

target firm's financial statements:

2020 2019 2018

EBIT: 5,998,321 5,960,124 4,923,478

Tax Liability: 1,259,647 1,251,626 1,033,930

Depreciation: 239,895 1,239,239 605,752

change in Fixed Assets: 1,903,500 2,580,000 2,173,000

change in Current Assets: 5,975,324 7,210,800 8,501,348

change in (AP + Accruals): 4,116,364 5,905,791 7,600,543

Here are some equations from chapter 4 that you will need:

FCF = OCF - Net fixed asset investment (NFAI) - Net current asset investment (NCAI)

OCF = (EBIT - Tax Liability) + Depreciation

NFAI = Change in net fixed assets + Depreciation

NCAI = Change in current assets - Change in (accounts payable + accruals)

Questions:

1. What is the target firm's annual free cash flow for 2018-2020?

2. What is the annual growth rate of the target firm's annual free cash flow from 2018-2020?

3. If you expect the target firm to grow at your calculated annual growth rate for the next four years (2021-

2024) and then beyond grow at an annual rate of 2%, , what is the value of the entire target firm assuming

a weighted average cost of capital (WACC) of 10.5%?

4. The target firm's current stock price is $20, and it has 1,200,000 shares of common stock outstanding. Based

on your calculation of the entire target firm value, is the target firm's stock overvalued or undervalued?

5. Based on your evaluation of the target firm's current share price, would you suggest moving forward with

the acquisition? Why or why not?