Questions #3

ABC Company's CFO has provided a long-term forecast for ABC as follows:

EBITNet IncomeDiscount Factor

2020$42,000,000$20,000,0000.91

2021$44,000,000$21,000,0000.83

2022$46,000,000$22,000,0000.75

2023$48,000,000$23,000,0000.68

2024$50,000,000$24,000,0000.62

Assumptions:

The growth rate after 2024 is 3%

XYZ Company uses a 10% weighted average cost of capital (WACC) and a minimum required return on equity of 13.33%

The tax rate is 50%

The company pays $2,000,000 a year in interest for all years

Depreciation is expected to be $5,000,000 per year

oAfter 2020, new equipment purchases are expected to be $10,000,000 a year

oAfter 2020, net cash outflow of these two items is ($5,000,000) a year

oSee expenditures for 2020 above which is a one-time modernization year

Net working capital changes are assumed to be ($1,000,000) a year as sales grow

The terminal value of the company at the end of 2024 is $280,000,000

The purchase will take place at thebeginning of 2020, if accepted

Required:

(1)Prepare valuation of ABC Company's common shares using the free cash flow to the firm method and subtracting debt. (10 marks)

(2)What is the EBITDA based intrinsic value of ABC Company using 2020 data. Subtract debt to obtain the intrinsic value of the shares. (4 marks)

(3)What are three (3) assumptions in the valuation calculation you would advise XYZ Company's CFO to keep in mind in assessing the sensitivity of results of the valuation. (3 marks)

(4)Do you think the company is a buy, yes or no? Is goodwill a factor in the decision? Given reasons for your answers. (3 marks)

(20 total marks)