Challenge Problem: Chapter 7 BUSFIN1030 Due: October 28, 2020 For challenge problems, answers must be in your own handwriting and you must show all mathematical calculations. 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 flow (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 A Fixed Assets 1,903,500 2,580,000 2,173,000 A Current Assets 5,975,324 7.210,800 8,501,348 A (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 riext 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? 1 Challenge Problem: Chapter 7 BUSFIN1030 Due: October 28, 2020 For challenge problems, answers must be in your own handwriting and you must show all mathematical calculations. 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 flow (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 A Fixed Assets 1,903,500 2,580,000 2,173,000 A Current Assets 5,975,324 7.210,800 8,501,348 A (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 riext 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? 1