Question 4. Cash Flow Valuation Model

A local investment banking firm, Denver Creek Inc., is evaluating a deal to acquire a sports apparel company, Breezee.

The company has a term loan requiring monthly payment and the principal of the loan to be paid down over the life of the loan (that is, amortized). The debt balance at year 0 is $150 million and the loan rate is 5% (APR or annual percentage rate =5%). The loan will mature at year 3 or in 36 months.

In the long term, the company plans to manage its capital structure to a target debt-to-value ratio. The target is set at the industry average level of 20%. When the term loan matures at the end of year 3, the company will refinance with new debt to reach the target level and will keep the debt ratio at 20% in the steady state (starting year 4).

The companys capital structure over time is presented in the table below.

	Year 0	Year 1	Year 2	Year 3	Year 4
Debt-to-Value Ratio	80%	60%	40%	20%	20%
$ Debt ('mm)	150.0			40.0
Free Cash Flow to Firm (mm)		20	30	50

Other inputs and assumptions:Unlevered cost of capital (Ru) = 9%; Cost of capital (Rwacc) in the steady state = 11% Tax rate = 21%; Long-term growth rate (LTg) = 2%

1. Determine the term loans monthly total payment, principle repayment andinterest payment, and construct the amortization schedule.Note: An amortization schedule is a complete table of periodic loan payments, showing the amount of principal repayment and the amount of interest that comprise each payment until the loan is paid off at the end of its term.

2. Choose the appropriate cash flow valuation model and explain your rationale.

3. Apply the model of your choice and estimate the target companys value of operation.