Slim Perkins, a business journalist, is a recent hire at his firm. Since he joined the firm, he has been following Facebook Inc.s (FB) initial public offering (IPO) and the stocks performance. His task is to estimate Facebooks fair market value, also referred to as intrinsic value, and compare this value with the current stock price, and recommend a buy, sell, or hold rating to investors. Slim pulls the companys consolidated financial statements to collect relevant data on the companys historical financial performance. He notices that the company assumes a 45% marginal tax rate after the IPO, and mentions that the company projects that user rates and revenue growth will decline over time. Slim starts his evaluation by calculating ratios of costs and expenses to revenues, interest expense to revenues, and others that will form the set of assumptions in his analysis which will be used to calculate free cash flows.

Got lost in trying to solve this and not sure of any of the work done. This is all a single question and everything builds on the step before it.

Balance Sheet Income Statement Statement of Stockholder's Equity Statement of Cash Flows 2011 (in millions) $3,711 2010 (in millions) $1,974 2009 (in millions) $777 493 184 144 223 115 860 427 388 280 $1,955 $1,756 121 $942 $1,032 90 $515 $262 Revenue Costs and expenses Cost of revenue Marketing and sales Research and development General and administrative Total costs and expenses Income from operations Interest and other income (expense), net: Interest expense Other income (expense), net Income before provision for income taxes Provision for income taxes Net income Net income attributable to participating securities Net income attributable to class A and class B common stockholders $(22) $(10) $254 $(42) (19) $1,695 695 $1,000 332 $668 25 (2) $1,008 402 $606 234 $372 $229 107 $122 Source: Facebook Inc. Prospectus. United States Securities and Exchange Commission, 17 May 2012. Web. 1 June 2012 http://www.sec.gov/Archives/edgar/data/1325801/000119312512240111/d287954d424b4.htm#toc Balance Sheet Income Statement Statement of Stockholder's Equity Statement of Cash Flows Balances at Dec 31 (in millions) (in millions) (in millions) 2011 2010 2009 $615 $615 $615 - 947 Convertible preferred stock Class A and Class B common stock Additional paid-in capital Accumulated other comprehensive loss Retained earnings (accumulated deficit) Total stockholders' equity 253 - 2,684 (6) 1,606 $4,899 606 $2,162 $868 Source: Facebook Inc. Prospectus. United States Securities and Exchange Commission, 17 May 2012. Web. 1 June 2012 http://www.sec.gov/Archives/edgar/data/1325801/000119312512240111/d287954d424b4.htmetoc Balance Sheet Income Statement Statement of Stockholder's Equity Statement of Cash Flows 2011 (in millions) 2010 (in millions) 2009 (in millions) $1,000 5506 5229 323 OHNE (209) (112) $1,549 5698 $155 Cash flows from operating activities Net income Adjustments to reconcile net earnings to net cash from operating activities: Depreciation and amortization Loss on write-off of assets Share-based compensation Other adjustments Changes in assets and liabilities: Accounts receivable Prepaid expenses and other current assets Other assets Accounts payable Platform partners payable Accrued expenses and other current liabilities Deferred revenues and deposits Other liabilities Net cash provided by operating activities Cash flows from investing activities Purchases of property and equipment Purchases of marketable securities Maturities of marketable securities Sales of marketable securities Investments in non-marketable equity securities Acquisitions of business, net of cash acquired Change in restricted cash and deposits Net cash used in investing activities Cash flows from financing activities Net proceeds from issuance of convertible preferred stock Net proceeds from issuance of common stock Proceeds from exercise of stock options Proceeds from (repayments of) long-term debt Proceeds from sale and lease-back transactions Principal payments on capital lease obligations Excess tax benefit from share-based award activity Net cash provided by financing activities Non-cash financing activities: Property and equipment acquired under capital leases s(293) s(606) (3,025) 516 113 (3) (24) (32) $(62) $(3,023) $(324) $200 $500 250 5998 28 (250) 170 (181) 433 $1,198 (48) (90) 115 $781 $243 473 217 Average 2011 23.17 % 696 2010 24.07% 481 2009 28.70% ] 25.62% 50.98% Estimated Assumptions 1. Total cost and expenses as a percentage of revenue 2. Operating current assets (in millions) 3. Growth in operating current assets 4. Operating current liabilities (in millions) 5. Growth in operating current liabilities 6. Depreciation and amortization as a percentage of revenues 7. Net fixed assets as a percentage of revenues 620 283 8.70% 39.75 % 7.04 % 29.08 % 10.04 % 19.05% 119.08 % 8.59 % 29.29% Slim posts his strategy on his social networking page to get some suggestions from his friends. Follow the discussion and complete the missing information: Since Facebook named Google as its prime competitor,l1 I am inclined to use Google Inc.'s post-IPO performance as a benchmark for FB's expected financial performance for at least three to four years following the IPO. Does anyone already have the growth rates for Google's post-IPO revenues? NATALYA: Hi Slim, according to a trading blog 12 I follow, Google's post-IPO average revenue growth over five quarters was 18%. SLIM: Thank you, Natalya! I also discovered in the annual report that FB's internal projections use a 5% perpetual growth rate. I will be using a two-stage discounted cash flow model. I will base my FCF calculations on the following equation: FCF = Net Operating Profit After Taxes + Depreciation - Capital Expenditure - A in Net Operating Working Capital Am I missing something? TED: Slim, just one very important point. In your NOWC calculations I recommend using the growth in current assets as the assumption for growth in current liabilities after two years because current liabilities cannot grow faster than current assets forever. Such rundown on WC is not sustainable You could use Google's WACC in your calculations. Google is currently using a 9.5% WACC. Investors would require an additional premium of 7.5% for Facebook's stock. SLIM: Thanks, Ted! This information is really helpful. Using Google as a comparable, it would be fair to use these values to calculate FB's investors' required rate of return, which will be 11.0% [1] Brandon Hunter, Jesse Fischer, and Shafiel Karim, "What Facebook Is Really Worth," Seeking Alpha (blog), May 15, 2012, http://seeking alpha.com/article/589741-what- facebook-is-really-worth. [2] Husky Financial, "Facebook Vs. Google: What You Need To Know Post-IPO," Seeking Alpha (blog), May 17, 2012, http://seekingalpha.com/article/598731-facebook-vs-google- what-you-need-to-know-post-ipo After discussing the different aspects of the valuation, Slim puts together his FCF projections. Complete the missing elements from his projection: 2014 2018 (in millions) (in 2012 (in millions) 18% 2013 (in millions) 18% 2015 (in millions) 18% 2016 (in millions) 2017 (in millions) 5% millions) 18% 1896 Revenue growth rate Revenues $ 5% 9,360 4,379 5.167 7.195 8.400 8014 - Total costs and expenses Income from operations (EBIT) - Taxes Net operating profit after taxes (NOPAT) Operating current assets Operating current liabilities NOWC Change in NOWC Net fixed assets (plant property & equipment) Change in net fixed assets + Depreciation and amortization Capital expenditure Free cash flow Present value of FCF Horizon value Present value of horizon value Total firm value The value of total long-term liabilities that FB reported in 2011 was $ million, and the value of preferred stock in 2011 was $ million. Thus, using the firm's value, the derived equity value will be million. The company issued shares of class A common stock in 2012. Thus, the value of each stock, rounded to two decimal places, is According to the SEC filings, FB stock's IPO was priced at $38.00 per share. If Slim strictly follows the theoretical rules of investing, based on his analysis, what strategy would he recommend to investors interested in FB's stock as an asset in their short-term investment portfolio? Buy Hold Sell Balance Sheet Income Statement Statement of Stockholder's Equity Statement of Cash Flows 2011 (in millions) $3,711 2010 (in millions) $1,974 2009 (in millions) $777 493 184 144 223 115 860 427 388 280 $1,955 $1,756 121 $942 $1,032 90 $515 $262 Revenue Costs and expenses Cost of revenue Marketing and sales Research and development General and administrative Total costs and expenses Income from operations Interest and other income (expense), net: Interest expense Other income (expense), net Income before provision for income taxes Provision for income taxes Net income Net income attributable to participating securities Net income attributable to class A and class B common stockholders $(22) $(10) $254 $(42) (19) $1,695 695 $1,000 332 $668 25 (2) $1,008 402 $606 234 $372 $229 107 $122 Source: Facebook Inc. Prospectus. United States Securities and Exchange Commission, 17 May 2012. Web. 1 June 2012 http://www.sec.gov/Archives/edgar/data/1325801/000119312512240111/d287954d424b4.htm#toc Balance Sheet Income Statement Statement of Stockholder's Equity Statement of Cash Flows Balances at Dec 31 (in millions) (in millions) (in millions) 2011 2010 2009 $615 $615 $615 - 947 Convertible preferred stock Class A and Class B common stock Additional paid-in capital Accumulated other comprehensive loss Retained earnings (accumulated deficit) Total stockholders' equity 253 - 2,684 (6) 1,606 $4,899 606 $2,162 $868 Source: Facebook Inc. Prospectus. United States Securities and Exchange Commission, 17 May 2012. Web. 1 June 2012 http://www.sec.gov/Archives/edgar/data/1325801/000119312512240111/d287954d424b4.htmetoc Balance Sheet Income Statement Statement of Stockholder's Equity Statement of Cash Flows 2011 (in millions) 2010 (in millions) 2009 (in millions) $1,000 5506 5229 323 OHNE (209) (112) $1,549 5698 $155 Cash flows from operating activities Net income Adjustments to reconcile net earnings to net cash from operating activities: Depreciation and amortization Loss on write-off of assets Share-based compensation Other adjustments Changes in assets and liabilities: Accounts receivable Prepaid expenses and other current assets Other assets Accounts payable Platform partners payable Accrued expenses and other current liabilities Deferred revenues and deposits Other liabilities Net cash provided by operating activities Cash flows from investing activities Purchases of property and equipment Purchases of marketable securities Maturities of marketable securities Sales of marketable securities Investments in non-marketable equity securities Acquisitions of business, net of cash acquired Change in restricted cash and deposits Net cash used in investing activities Cash flows from financing activities Net proceeds from issuance of convertible preferred stock Net proceeds from issuance of common stock Proceeds from exercise of stock options Proceeds from (repayments of) long-term debt Proceeds from sale and lease-back transactions Principal payments on capital lease obligations Excess tax benefit from share-based award activity Net cash provided by financing activities Non-cash financing activities: Property and equipment acquired under capital leases s(293) s(606) (3,025) 516 113 (3) (24) (32) $(62) $(3,023) $(324) $200 $500 250 5998 28 (250) 170 (181) 433 $1,198 (48) (90) 115 $781 $243 473 217 Average 2011 23.17 % 696 2010 24.07% 481 2009 28.70% ] 25.62% 50.98% Estimated Assumptions 1. Total cost and expenses as a percentage of revenue 2. Operating current assets (in millions) 3. Growth in operating current assets 4. Operating current liabilities (in millions) 5. Growth in operating current liabilities 6. Depreciation and amortization as a percentage of revenues 7. Net fixed assets as a percentage of revenues 620 283 8.70% 39.75 % 7.04 % 29.08 % 10.04 % 19.05% 119.08 % 8.59 % 29.29% Slim posts his strategy on his social networking page to get some suggestions from his friends. Follow the discussion and complete the missing information: Since Facebook named Google as its prime competitor,l1 I am inclined to use Google Inc.'s post-IPO performance as a benchmark for FB's expected financial performance for at least three to four years following the IPO. Does anyone already have the growth rates for Google's post-IPO revenues? NATALYA: Hi Slim, according to a trading blog 12 I follow, Google's post-IPO average revenue growth over five quarters was 18%. SLIM: Thank you, Natalya! I also discovered in the annual report that FB's internal projections use a 5% perpetual growth rate. I will be using a two-stage discounted cash flow model. I will base my FCF calculations on the following equation: FCF = Net Operating Profit After Taxes + Depreciation - Capital Expenditure - A in Net Operating Working Capital Am I missing something? TED: Slim, just one very important point. In your NOWC calculations I recommend using the growth in current assets as the assumption for growth in current liabilities after two years because current liabilities cannot grow faster than current assets forever. Such rundown on WC is not sustainable You could use Google's WACC in your calculations. Google is currently using a 9.5% WACC. Investors would require an additional premium of 7.5% for Facebook's stock. SLIM: Thanks, Ted! This information is really helpful. Using Google as a comparable, it would be fair to use these values to calculate FB's investors' required rate of return, which will be 11.0% [1] Brandon Hunter, Jesse Fischer, and Shafiel Karim, "What Facebook Is Really Worth," Seeking Alpha (blog), May 15, 2012, http://seeking alpha.com/article/589741-what- facebook-is-really-worth. [2] Husky Financial, "Facebook Vs. Google: What You Need To Know Post-IPO," Seeking Alpha (blog), May 17, 2012, http://seekingalpha.com/article/598731-facebook-vs-google- what-you-need-to-know-post-ipo After discussing the different aspects of the valuation, Slim puts together his FCF projections. Complete the missing elements from his projection: 2014 2018 (in millions) (in 2012 (in millions) 18% 2013 (in millions) 18% 2015 (in millions) 18% 2016 (in millions) 2017 (in millions) 5% millions) 18% 1896 Revenue growth rate Revenues $ 5% 9,360 4,379 5.167 7.195 8.400 8014 - Total costs and expenses Income from operations (EBIT) - Taxes Net operating profit after taxes (NOPAT) Operating current assets Operating current liabilities NOWC Change in NOWC Net fixed assets (plant property & equipment) Change in net fixed assets + Depreciation and amortization Capital expenditure Free cash flow Present value of FCF Horizon value Present value of horizon value Total firm value The value of total long-term liabilities that FB reported in 2011 was $ million, and the value of preferred stock in 2011 was $ million. Thus, using the firm's value, the derived equity value will be million. The company issued shares of class A common stock in 2012. Thus, the value of each stock, rounded to two decimal places, is According to the SEC filings, FB stock's IPO was priced at $38.00 per share. If Slim strictly follows the theoretical rules of investing, based on his analysis, what strategy would he recommend to investors interested in FB's stock as an asset in their short-term investment portfolio? Buy Hold Sell