Jones Group Inc is the parent company of Midwest Pipeline Inc , a mature, stable natural gas transmission pipeline company in the United States In 1998, Jones Group established DCom Corp , a 100 percent owned subsidiary whose mandate is to install and commercialize a long haul data communications network Tom Anderson, Chief Executive Officer of DCom, hires Vala and Associates to provide additional insight into capital markets and corporate finance issues During the initial meeting in December 2000 with Jim Vala, CFA, Anderson comments I do not believe the full value of DCom is reflected in the market price of Jones Group equity I think DComs full value can be determined using the free cash flows to the firm model Vala has the following notes from his initial meeting with Anderson The data communications network was built on existing property alongside Midwest Pipelines transmission pipelines The major network construction is nearing completion and DComs sales force is now in place Network data traffic is expected to grow at a rate of 50 percent annually through 2003 and 15 percent annually thereafter Beginning in 2004, DComs free cash flows to the firm are expected to grow at a sustainable rate of 15 percent annually The weighted average cost of capital for DCom is 17 percent The appropriate tax rate for DCom is 30 percent Calculate the total firm value of DCom at the end of year 2000, using the free cash flows to the firm (FCFF) model State whether total firm value as determined by the FCFF model is appropriate to assess the value that DCom should contribute to the market price of Jones Group equity Support your response with one reason Exhibit 1 3 DCom Corp Summary Income Statement and Balance Sheet (U S $ millions, except per share data) December 31 $ $ $ 2000 2001 2002 2003 Actual Projection Projection Projection 70 00 $ 105 00 $ 157 50 $ 236 25 30 45 $ 45 68 $ 68 51 $ 102 77 39 55 $ 59 32 $ 88 99 $ 133 48 Summary Income Statement (for the year) Total Revenue Total Operating Expenses Earnings Before Interest, Taxes, Depreciation Amortization (EBITDA) Depreciation and Amortization Earnings Before Interest Taxes (EBIT) Interest Expense Pre tax Income Income Tax Expense Net Income $ 69 00 $ 129 00 $ 136 50 $ 144 00 $ (29 45) $ (69 68) $ (47 51) $ (10 52) $ 44 10 $ 79 20 $ 87 75 $ 87 75 $ (73 55) $ (148 88) $ (135 26) $ (98 27) $ (22 07) $ (44 66) $ (40 58) $ (29 48) $ (51 49) $ (104 22) $ (94 68) $ (68 79) Summary Balance Sheet (year end) Total Current Assets Net Fixed Assets Total Assets 2000 2001 2002 2003 Actual Projection Projection Projection $ 113 12 $ 130 93 $ 222 07 $ 253 75 $ 391 00 $ 662 00 $ 575 50 $ 481 50 $ 504 12 $ 792 93 $ 797 57 $ 735 25 Total Current Liabilities Long term Debt Total Liabilities Common Stock Retained Earnings Total Shareholder's Equity Total Liabilities and Equity $ 5 60 $ 8 63 $ 12 95 $ 19 42 $ 490 00 $ 880 00 $ 975 00 $ 975 00 $ 495 60 $ 888 63 $ 987 95 $ 994 42 $ 60 00 $ 60 00 $ 60 00 $ 60 00 $ (51 49) $ (155 70) $ (250 38) $ (319 17) $ 8 51 $ (95 70) $ (190 38) $ (259 17) $ 504 12 $ 792 93 $ 797 57 $ 735 25 Dividends $ $ $ $ Capital Expenditures Changes in Working Capital (excluding cash and short term debt) $ $ 400 00 5 19 $ $ 50 00 $ (4 32) $ 50 00 (6 47)

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Jones Group Inc. is the parent company of Midwest Pipeline Inc., a mature, stable natural gas transmission pipeline company in the United States. In 1998,

Jones Group Inc. is the parent company of Midwest Pipeline Inc., a mature, stable natural gas transmission pipeline company in the United States. In 1998, Jones Group established DCom Corp., a 100 percent owned subsidiary whose mandate is to install and commercialize a long-haul data communications network.

Tom Anderson, Chief Executive Officer of DCom, hires Vala and Associates to provide additional insight into capital markets and corporate finance issues. During the initial meeting in December 2000 with Jim Vala, CFA, Anderson comments:

I do not believe the full value of DCom is reflected in the market price of Jones Group equity. I think DComs full value can be determined using the free cash flows to the firm model.

Vala has the following notes from his initial meeting with Anderson:

The data communications network was built on existing property alongside Midwest Pipelines transmission pipelines.
The major network construction is nearing completion and DComs sales force is now in place
Network data traffic is expected to grow at a rate of 50 percent annually through 2003 and 15 percent annually thereafter.
Beginning in 2004, DComs free cash flows to the firm are expected to grow at a sustainable rate of 15 percent annually.
The weighted average cost of capital for DCom is 17 percent.
The appropriate tax rate for DCom is 30 percent.

Calculate the total firm value of DCom at the end of year 2000, using the free cash flows to the firm (FCFF) model.

State whether total firm value as determined by the FCFF model is appropriate to assess the value that DCom should contribute to the market price of Jones Group equity.

Support your response with one reason. image text in transcribed

Exhibit 1-3 DCom Corp. Summary Income Statement and Balance Sheet (U.S. $ millions, except per share data) December. 31 $ $ $ 2000 2001 2002 2003 Actual Projection Projection Projection 70.00 $ 105.00 $ 157.50 $ 236.25 30.45 $ 45.68 $ 68.51 $ 102.77 39.55 $ 59.32 $ 88.99 $ 133.48 Summary Income Statement (for the year) Total Revenue Total Operating Expenses Earnings Before Interest, Taxes, Depreciation & Amortization (EBITDA) Depreciation and Amortization Earnings Before Interest & Taxes (EBIT) Interest Expense Pre-tax Income Income Tax Expense Net Income $ 69.00 $ 129.00 $ 136.50 $ 144.00 $ (29.45) $ (69.68) $ (47.51) $ (10.52) $ 44.10 $ 79.20 $ 87.75 $ 87.75 $ (73.55) $ (148.88) $ (135.26) $ (98.27) $ (22.07) $ (44.66) $ (40.58) $_(29.48) $ (51.49) $ (104.22) $ (94.68) $ (68.79) Summary Balance Sheet (year end) Total Current Assets Net Fixed Assets Total Assets 2000 2001 2002 2003 Actual Projection Projection Projection $ 113.12 $ 130.93 $ 222.07 $ 253.75 $ 391.00 $ 662.00 $ 575.50 $ 481.50 $ 504.12 $ 792.93 $ 797.57 $ 735.25 Total Current Liabilities Long-term Debt Total Liabilities Common Stock Retained Earnings Total Shareholder's Equity Total Liabilities and Equity $ 5.60 $ 8.63 $ 12.95 $ 19.42 $ 490.00 $ 880.00 $ 975.00 $ 975.00 $ 495.60 $ 888.63 $ 987.95 $ 994.42 $ 60.00 $ 60.00 $ 60.00 $ 60.00 $ (51.49) $ (155.70) $ (250.38) $ (319.17) $ 8.51 $ (95.70) $ (190.38) $ (259.17) $ 504.12 $ 792.93 $ 797.57 $ 735.25 Dividends $ - $ - $ - $ - Capital Expenditures Changes in Working Capital (excluding cash and short-term debt) $ $ 400.00 5.19 $ $ 50.00 $ (4.32) $ 50.00 (6.47)