great work on the attached project. It was very helpful to me. I have a few questions I could use your assistance on for the same company and data. Can you help in computing the following? See attached file.

Residual Income Value to Book Free Cash Flow to Equity (FCFE) Free Cash Flow to Company (FCFC, Debt and Equity)

you are required to perform valuation for HES Company as given below. Show detail work and discuss any assumptions you make. Consider HES Company's financial statements given below. Assume the Company's beta is estimated to be 1.5, risk free rate 2%, and market risk premium 10%. Furthermore, assume the company has a long-term growth rate for 2% after the fifth year and net income and comprehensive income will be identical. What is the company's value using the following methods: a) Residual Income b) Free Cash Flow c) If Owners decide to issue 1,000,000 common shares, how much would be the value for each share? d) Analyze and explain which one of the above valuation methods provides a better and more realistic valuation. Revenues Cost of Sales Gross Profit Accounting Advertising & Promotion Bank Charges Compensation & Benefits Consulting Fees Insurance Lease - Facilities Legal & Professional Licenses & Fees Maintenance Miscellaneous Office supplies Security Telephone Utilities Website Total Operating Exp. EBIDTA Depreciation Operating Profit Interest Expense Earnings Before Taxes Income Taxes Net Income Income Statement Year 1 Year 2 Year 3 Year 4 Year 5 $1,976,000 $2,074,800 $2,178,540 $2,287,467 $2,401,840 1,213,659 1,274,342 1,338,059 1,404,962 1,475,210 $762,341 $800,458 $840,481 $882,505 $926,630 6,000 6,300 6,615 6,946 7,293 15,000 12,360 12,731 13,113 13,506 41,496 43,571 45,749 48,037 50,439 246,643 254,042 261,663 269,513 277,598 2,400 1,000 336,000 500 500 600 1,800 2,700 720 1,800 4,200 1,800 663,159 $99,182 4,916 $94,266 43,199 51,067 17,873 $33,194 0 1,050 336,000 500 510 612 1,836 2,754 742 1,836 4,410 1,800 668,323 $132,135 4,916 $127,219 40,274 86,945 30,431 $56,514 0 1,103 336,000 500 520 624 1,873 2,809 764 1,873 4,631 1,800 679,255 $161,226 4,916 $156,310 37,059 119,251 41,738 $77,513 0 1,158 336,000 500 531 637 1,910 2,865 787 1,910 4,862 1,800 690,569 $191,936 4,916 $187,020 33,524 153,496 53,724 $99,772 0 1,216 336,000 500 541 649 1,948 2,923 810 1,948 5,105 1,800 702,276 $224,354 4,916 $219,438 29,639 189,799 66,429 $123,370 Year 3 Year 4 Balance sheets Begin Year 1 Year 2 Year 5 Cash Inventory Prepaid Leases Total Current Assets $33,150 425,000 28,000 $486,150 $110,697 425,000 28,000 $563,697 $210,697 424,781 28,000 $663,478 $243,259 446,020 28,000 $717,279 $293,834 $363,370 468,321 491,737 28,000 28,000 $790,155 $883,107 Fixed Assets Less: Depreciation Net Fixed Assets Total Assets 33,850 0 33,850 $520,000 33,850 4,916 28,934 $592,631 33,850 9,832 24,018 $687,496 33,850 14,747 19,103 $736,382 33,850 33,850 19,664 24,579 14,186 9,271 $804,341 $892,378 Accounts Payable Long Term Debt Total Liabilities Owner's Equity Paid-in Capital Retained Earnings Total Liabilities & Equity 0 468,000 468,000 68,908 438,529 507,437 139,654 406,133 545,787 146,637 370,522 517,159 153,968 331,377 485,345 161,667 288,346 450,013 52,000 0 52,000 33,194 52,000 89,709 52,000 167,223 52,000 266,996 52,000 390,365 $520,000 $592,631 $687,496 $736,382 $804,341 $892,378 Cash Flow Statements Operating Profit Add: Depreciation Working Capital Investment Cash From Operations Interest Expense Income Taxes Net Cash Before Debt Pmt Debt Payment Change in Cash Cash Reconciliation Beginning Cash Change in Cash Ending Cash Year 1 Year 2 Year 3 Year 4 Year 5 $94,266 4,916 99,182 $127,219 4,916 132,135 $156,310 4,916 161,226 $187,020 4,916 191,936 $219,438 4,916 224,354 -68,908 -70,966 14,256 14,968 15,719 168,090 43,199 17,873 203,101 40,274 30,431 146,970 37,059 41,738 176,968 33,524 53,724 208,635 29,639 66,429 107,018 132,396 68,173 89,720 112,567 29,471 $77,547 32,396 $100,000 35,611 $32,562 39,145 $50,575 43,031 $69,536 $33,150 77,547 $110,697 $110,697 100,000 $210,697 $210,697 32,562 $243,259 $243,259 50,575 $293,834 $293,834 69,536 $363,370 a is estimated to be 1.5, risk free erm growth rate for 2% after the or each share? more realistic valuation. (a) SOLUTION 0 Total assets Equity ratio Debt ratio(liabilities/assets) Cost of debt $486,150 1 $563,697 2 $663,478 3 $717,279 $0.10 $0.90 0 14% 0 $0.14 $0.86 0.09 14.0% 35.0% $0.21 $0.79 0.09 14.0% 35.0% $0.30 $0.70 0.09 14.0% 35.0% 0 0 0 0 0 $94,266 $127,219 $156,310 $43,199 $51,067 $17,873 $33,194 $40,274 $86,945 $30,431 $56,514 $37,059 $119,251 $41,738 $77,513 52,000 85,194 11927.16 141,709 19839.26 219,223 30691.22 0 $33,194 $11,927 $21,267 $56,514 $19,839 $36,675 $77,513 $30,691 $46,822 cost of capital ( rCAPM) Tax rate EBIT Less: Interest expense EBT Less: Income tax expense Net income Equity capital Equity charge (cost of equity) Net income Less: Equity charge Residual income(RI) Present value of RI @ WACC Book value, V at period t=0 Add:PV of continuing residual income TOTAL VALUE OF COMMON STOCK 0 19379.97557 30299.2462 34727.44986 342,365 $82,695 581,238 VALUE OF THE COMPANY USING THE RESIDUAL INCOME MODEL $ 581, 695 WACC WACC= cost of equity*weight of equity + cost of debt*weight of debt Year 1 Year 2 Year 3 Equity 52000 85194 141709 Debt 438529 406133 370522 Total debt and equity 490529 491327 512231 weight of equity 11% 17% 28% weight of debt 89% 83% 72% cost of equity 14% 14% 14% cost of debt 9% 9% 9% WACC 10% 10% 10% ASSUMPTIONS 4 $790,155 5 $883,107 $0.40 $0.60 0.09 14.0% 35.0% $0.50 $0.50 0.09 14.0% 35.0% $187,020 $219,438 $33,524 $153,496 $53,724 $99,772 $29,639 $189,799 $66,429 $123,370 318,996 44659.44 442,365 61931.1 $99,772 $44,659 $55,113 $123,370 $61,931 $61,439 36278.82636 35491.871 Year 4 Year 5 219223 318996 331377 288346 550600 607342 40% 53% 60% 47% 14% 14% 9% 9% 11% 12% cost of capital r =rf+Ba(rm-rf) =2%+1.5(10-2) r= 14% Equity charge = total equity x cost of capital Tax rate = tax expense / EBT Value of the company = book value + pv of RI RI- residual income RI=Net income-equity charge Persistence factor for continuing residual income=2% 2% Revenues Cost of Sales Gross Profit Accounting Advertising & Promotion Income Statement Year 1 Year 2 Year 3 Year 4 Year 5 $1,976,000 $2,074,800 $2,178,540 $2,287,467 $2,401,840 1,213,659 1,274,342 1,338,059 1,404,962 1,475,210 $762,341 $800,458 $840,481 $882,505 $926,630 6,000 15,000 41,496 246,643 2,400 1,000 336,000 500 500 600 1,800 2,700 720 1,800 6,300 12,360 43,571 254,042 0 1,050 336,000 500 510 612 1,836 2,754 742 1,836 6,615 12,731 45,749 261,663 0 1,103 336,000 500 520 624 1,873 2,809 764 1,873 6,946 13,113 48,037 269,513 0 1,158 336,000 500 531 637 1,910 2,865 787 1,910 7,293 13,506 50,439 277,598 0 1,216 336,000 500 541 649 1,948 2,923 810 1,948 Utilities 4,200 4,410 4,631 4,862 5,105 Website 1,800 1,800 1,800 1,800 1,800 663,159 668,323 679,255 690,569 702,276 $99,182 $132,135 $161,226 $191,936 $224,354 4,916 4,916 4,916 4,916 4,916 $94,266 43,199 51,067 17,873 $33,194 $127,219 40,274 86,945 30,431 $56,514 $156,310 37,059 119,251 41,738 $77,513 $187,020 33,524 153,496 53,724 $99,772 $219,438 29,639 189,799 66,429 $123,370 Year 2 Year 3 Year 4 $210,697 424,781 28,000 $663,478 $243,259 446,020 28,000 $717,279 $293,834 468,321 28,000 $790,155 Bank charges Compensation & Benefits Consulting Fees Insurance Lease - Facilities Legal & Professional Licenses & Fees Maintenance Miscellaneous Office supplies Security Telephone Total Operating Exp. EBIDTA Depreciation Operating Profit Interest Expense Earnings Before Taxes Income Taxes Net Income Balance sheets Begin Cash Inventory Prepaid Leases Total Current Assets $33,150 425,000 28,000 $486,150 Year 1 $110,697 425,000 28,000 $563,697 Fixed Assets Less: Depreciation Net Fixed Assets Total Assets Accounts Payable Long Term Debt Total Liabilities Owner's Equity Paid-in Capital Retained Earnings Total Liabilities & Equity 33,850 0 33,850 $520,000 33,850 4,916 28,934 $592,631 33,850 9,832 24,018 $687,496 33,850 14,747 19,103 $736,382 33,850 19,664 14,186 $804,341 0 468,000 468,000 68,908 438,529 507,437 139,654 406,133 545,787 146,637 370,522 517,159 153,968 331,377 485,345 52,000 0 $520,000 52,000 33,194 $592,631 52,000 89,709 $687,496 52,000 167,223 $736,382 52,000 266,996 $804,341 Year 2 Year 3 Year 4 Year 5 $94,266 4,916 99,182 -68,908 168,090 43,199 17,873 107,018 29,471 $77,547 $127,219 4,916 132,135 -70,966 203,101 40,274 30,431 132,396 32,396 $100,000 $156,310 4,916 161,226 14,256 146,970 37,059 41,738 68,173 35,611 $32,562 $187,020 4,916 191,936 14,968 176,968 33,524 53,724 89,720 39,145 $50,575 $219,438 4,916 224,354 15,719 208,635 29,639 66,429 112,567 43,031 $69,536 $33,150 77,547 $110,697 $110,697 100,000 $210,697 $210,697 32,562 $243,259 $243,259 50,575 $293,834 $293,834 69,536 $363,370 Cash Flow Statements Year 1 Operating Profit Add: Depreciation Working Capital Investment Cash From Operations Interest Expense Income Taxes Net Cash Before Debt Pmt Debt Payment Change in Cash Cash Reconciliation Beginning Cash Change in Cash Ending Cash Year 5 $363,370 491,737 28,000 $883,107 33,850 24,579 9,271 $892,378 161,667 288,346 450,013 52,000 390,365 $892,378 (b) SOLUTION Year 1 $1,976,000 1,213,659 $762,341 Total revenue less:Cost of Goods Sold Gross profit less:Selling, general and administrative expenses 663,159 $99,182 4,916 $94,266 Earnings before interest, taxes, depr. & amort. (EBITDA) less:Depreciation Earnings before Interest and taxes (EBIT) Federal and State Income Taxes 17,873 $33,194 Net Operating Profit After-Tax (NOPAT) Add :depreciation 4,916 less:Capital Expenditures less: New Net Working Capital 0 -68,908 $97,186 Free Cash Flow Termina value Present Value of Free Cash Flows @ WACC 88563.3364338504 5 Total Present Value of Company Operations Plus Current Assets Total Market Value $ WACC WACC= cost of equity*weight of equity + cost of debt*weight of debt Year 1 Equity 52,000 Debt 438,529 Total debt and equity 490,529 weight of equity 11% weight of debt cost of equity cost of debt WACC 89% 14% # 10% Year 2 Year 3 Year 4 Year 5 $2,074,800 1,274,342 $800,458 $2,178,540 1,338,059 $840,481 $2,287,467 1,404,962 $882,505 $2,401,840 1,475,210 $926,630 668,323 $132,135 4,916 $127,219 679,255 $161,226 4,916 $156,310 690,569 $191,936 4,916 $187,020 702,276 $224,354 4,916 $219,438 30,431 41,738 53,724 66,429 $56,514 $77,513 $99,772 $123,370 4,916 4,916 4,916 4,916 0 -70,966 0 14,256 0 14,968 0 15,719 $122,564 $58,341 $79,888 $102,735 154924.39467643 111402.59726647 52809.922063404 71958.517900874 230878.27774878 555612.651413381 $883,107 $1,438,720 Year 2 Year 3 Year 4 Year 5 85,194 141,709 219,223 318,996 406,133 370,522 331,377 288,346 491,327 512,231 550,600 607,342 17% 28% 40% 53% 83% 14% # 10% 72% 14% # 10% 60% 14% # 11% 47% 14% ## 12% Revenues Cost of Sales Gross Profit Income Statement Year 1 Year 2 Year 3 Year 4 Year 5 $1,976,000 $2,074,800 $2,178,540 $2,287,467 $2,401,840 1,213,659 1,274,342 1,338,059 1,404,962 1,475,210 $762,341 $800,458 $840,481 $882,505 $926,630 Accounting 6,000 6,300 6,615 6,946 7,293 Advertisin g& Promotion 15,000 12,360 12,731 13,113 13,506 Bank Charges 41,496 43,571 45,749 48,037 50,439 246,643 254,042 261,663 269,513 277,598 2,400 0 0 0 0 1,000 1,050 1,103 1,158 1,216 336,000 336,000 336,000 336,000 336,000 500 500 500 500 500 500 510 520 531 541 600 612 624 637 649 1,800 1,836 1,873 1,910 1,948 2,700 2,754 2,809 2,865 2,923 720 742 764 787 810 Telephone Utilities Website 1,800 4,200 1,800 1,836 4,410 1,800 1,873 4,631 1,800 1,910 4,862 1,800 1,948 5,105 1,800 Total Operating Exp. 663,159 668,323 679,255 690,569 702,276 $99,182 $132,135 $161,226 $191,936 $224,354 4,916 4,916 4,916 4,916 4,916 $94,266 $127,219 $156,310 $187,020 $219,438 43,199 40,274 37,059 33,524 29,639 51,067 86,945 119,251 153,496 189,799 Compensat ion & Benefits Consulting Fees Insurance Lease Facilities Legal & Professiona l Licenses & Fees Maintenan ce Miscellane ous Office supplies Security EBIDTA Depreciatio n Operating Profit Interest Expense Earnings Before Taxes Income Taxes Net Income 17,873 30,431 41,738 53,724 66,429 $33,194 $56,514 $77,513 $99,772 $123,370 Balance sheets Begin Cash Inventory Prepaid Leases Total Current Assets Fixed Assets Less: Depr eciation Net Fixed Assets Total Assets Accounts Payable Long Term Debt Total Liabilities Owner's Equity Paid-in Capital Retained Earnings Total Liabilities & Equity Year 1 Year 2 Year 3 Year 4 $33,150 425,000 $110,697 425,000 $210,697 424,781 $243,259 446,020 $293,834 468,321 $363,370 491,737 28,000 28,000 28,000 28,000 28,000 28,000 $486,150 $563,697 $663,478 $717,279 $790,155 $883,107 33,850 33,850 33,850 33,850 33,850 33,850 0 4,916 9,832 14,747 19,664 24,579 33,850 28,934 24,018 19,103 14,186 9,271 $520,000 $592,631 $687,496 $736,382 $804,341 $892,378 0 68,908 139,654 146,637 153,968 161,667 468,000 438,529 406,133 370,522 331,377 288,346 468,000 507,437 545,787 517,159 485,345 450,013 52,000 52,000 52,000 52,000 52,000 52,000 0 33,194 89,709 167,223 266,996 390,365 $520,000 $592,631 $687,496 $736,382 $804,341 $892,378 Cash Flow Statements Year 1 Operating Profit Add: Depr eciation Year 5 Year 2 Year 3 Year 4 Year 5 $94,266 $127,219 $156,310 $187,020 $219,438 4,916 4,916 4,916 4,916 4,916 99,182 132,135 161,226 191,936 224,354 Working Capital Investment Cash From Operations Interest Expense Income Taxes Net Cash Before Debt Pmt Debt Payment Change in Cash -68,908 -70,966 14,256 14,968 15,719 168,090 203,101 146,970 176,968 208,635 43,199 40,274 37,059 33,524 29,639 17,873 30,431 41,738 53,724 66,429 107,018 132,396 68,173 89,720 112,567 29,471 32,396 35,611 39,145 43,031 $77,547 $100,000 $32,562 $50,575 $69,536 $33,150 $110,697 $210,697 $243,259 $293,834 77,547 100,000 32,562 50,575 69,536 $110,697 $210,697 $243,259 $293,834 $363,370 Cash Reconciliat ion Beginning Cash Change in Cash Ending Cash c) If Owners decide to issue 1,000,000 common shares, how much would be the value for each share? (i) Residual Income approach value of a share = total market value/ no. of shares =$ 287,669/1,000,000 0.287669 value of a share = $ 0.29 (ii) Discounted cashflows value of a share = total market value/ no. of shares = $ 1,438,720/1,000,000 1.423141 value of a share = $1.42 d) Solution. (i) The residual income approach values the firm at $ 581, 695 while the free cash flows method value the firm The residual income approach shows the economic profit after deducting the cost of equity, which is the actua While the free cashflows use a terminal value of cashflows in the model, the resudual income approach use th which is more realistic considering that cashflows are highly uncertain in future periods since it is not possible value for each share? sh flows method value the firm at $ 1,438,720 ost of equity, which is the actual value created by the firm to the shareholders. udual income approach use the actual book value of the common stock at the time of of valuation periods since it is not possible to assess with certainty the ability of the firm to earn the cashflows