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Following Q2, the financial manager of company XXX is tempted to acquire company YYY. Company YYY is a private company without stock market price. However,

  1. Following Q2, the financial manager of company XXX is tempted to acquire company YYY. Company YYY is a private company without stock market price. However, it is in the same line of business as company XXX, you can assume it has the same business risk. The following table sets out the information that you need to forecast company YYYs free cash flows (the highlighted numbers are all forecasted numbers). You can assume the cash flow in year 0 has already occurred when you calculate the value of the business. Value horizon is 3 years. From year 4 onward, you assume a long-term growth rate of 3% each. Now assume Company XXX plans to finance the purchase with $30,000 of debt. It intends to pay down the debt to $22,234 in year 3 so that the debt ratio at the horizon is 25%, the normal debt ratio of company XXX.

0

1

2

3

4

Sales

70000

71000

72000

73000

74000

Cost of goods sold

56000

56800

57600

46080

59200

Net working capital

10000

10142

10286

10429

10571

Depreciation

3000

4000

4000

4000

4000

Gross fixed assets

60000

65000

70000

76000

82000

Debt

30000

28000

25000

22234

Investment in fixed assets

(change in gross fixed assets)

7000

Investment in working capital

300

You will use APV method to calculate the value of company YYY (keep four decimals). Show are your inputs to get full credit.

(a). Whats profit after tax in year 2? Show your inputs to get full credit.

(b). Whats free cash flow in year 2? Show your inputs to get full credit.

(c). Whats after-tax WACC and cost of capital of company XXX?

(d). Whats horizon value (not the present value)?

(e). Whats the base-case PV of company? Whats the PV of interest tax shields? Whats the PV of company YYY?

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