Financial information for GoGear Stores is given below.It is the end of 2020.Management expects sales to increase 15 percent in 2021 and 10 percent in 2022; after that, sales growth is expected to drop down to 4% a year, into the indefinite future.Management also believes the gross profit margin will improve permanently to 50% by next year.Meanwhile, selling and administrative costs are expected to rise by 10% in each of the next two years, after which they will remain at the ratiotosales reached in 2022.The company's effective tax rate is expected to be 27 percent.

GoGear Stores currently has $6 million of net working capital (which includes the cash needed to run the business).In future, management expects net working capital to be about 20% of sales.

Net fixed assets at year end 2020 are $18 million.Management expects to invest $6 million during 2021 and another $3 million in 2022 in plant and equipment to enable the firm to meet sales projections (these expenditures cover both the amounts need to replace depreciated assets and provide additional capacity).These investments will increase annual depreciation to $2.04m in 2021 and to $2.22m in 2022.After 2022, net fixed asset turnover will stabilize at 1.5, and depreciation will be 10% of beginningofyear net fixed assets.

a. Prepare pro forma income statements for 20212023 (for simplicity, assume interest expense remains constant).

b. Calculate (firm) free cash flow for the years 20212023.

[FCFF = EBIT*(1-tax rate) + Depreciation - CAPEX (capital investment) - change NWC + other adj]

NOPLAT = EBIT*(1-tax rate)

NWC = working capital adjustment

c. Value GoGear's equity assuming a discount rate of 11% and a total debt at the end of 2020 of $7.2 million.Compare and contrast GoGear's value under (a) the projected growth assumptions given above and (b) the value obtained under the assumption that after 2023, GoGear's market is competitive (that is, PVGO=0).

d. For each of the two valuations obtained in part c. above, find GoGear's market value debt ratio at the end of 2020, as well as its (trailing) AMV/EBITDA and P/E multiples³

e. You have identified industry peers for GoGear Stores, which indicate that it should trade at a trailing AMV/EBITDA of 8 and P/E of 14.What would these multiples imply about the value of GoGear's equity today?

f. Suppose you were to use one of today's peer multiples to obtain a remainder value for the end of 2023. How would your estimate differ from your remainder value estimates obtained in part c.?What economic factors do you think could explain the difference?

g. Conclude by stating a range of value for GoGear's equity today and explaining why you have reached this conclusion.

GoGear Stores

Income Statement for 2020 (thousands)

Net Sales$27,000

Cost of goods sold $14,850

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Gross margin $12,150

Operating expenses:

Sales and administrative$7,350

Depreciation $1,500

Operating income $3,300

Interest$600

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$2,700

Income taxes $675

Net income $2,025

³AMV is Adjusted Market Value (or Enterprise Value): the value of the entire firm excluding (excess) cash if any.