It is the end of 2019 and Management of XYZ survival appliance store expects sales to increase by 15 percent in 2020 and 10 percent in 2021; after then, sales growth is expected to slow 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 ratio-to-sales reached in 2021. The company's effective tax rate is expected to be 35 percent.

XYZ 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 2019 are $18 million. Management expects to invest $6 million during 2020 and another $3 million in 2021 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 2020 and to $2.22m in 2021. After 2021, net fixed asset turnover will stabilize at 1.5, and depreciation will be 10% of beginning-of-year net fixed assets.Assume interest expense remains constant

a. Calculate (firm) free cash flow for the years 2020-2022.

b. Value XYZ's equity assuming a discount rate of 11% and a total debt at the end of 2019 of $7.2 million. How can we compare and contrast XYZ's value under the projected growth assumptions given above and the value obtained under the assumption that after 2022, XYZ's market is competitive (that is, PVGO=0).

c. For each of the two valuations obtained in part c. above, find XYZ's market value debt ratio at the end of 2019, as well as its (trailing) AMV/EBITDA and P/E multiples

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

d. the identified industry peers for XYZ Stores, which indicate that it should trade at a trailing AMV/EBITDA of 9 and P/E of 14. What would these multiples imply about the value of XYZ's equity today?

f. Suppose today's peer multiples were used to obtain a remainder value for the end of 2022. How would the estimate differ from the remainder value estimates obtained in part c.? What economic factors could explain the difference?

g. State a range of value for XYZ's equity today and explain why you have reached this conclusion.

XYZ Stores

Income Statement for 2019 (thousands)

Net Sales $27,000

Cost of goods sold $14,850

Gross margin $12,150

Operating expenses:

Sales and administrative $7,350

Depreciation $1,500

Operating income $3,300

Interest $600

$2,700

Income taxes$675

Net income $2,025