9-5 Traditional WACC Valuation The owner of Big Boy Flea Market (BBFM), Lewis Redding, passed away on December 30, 2014. His 100% ownership interest in BBFM became part of his estate, on which his heirs must pay estate taxes. The IRS has hired a valuation expert, who has submitted a report stating that the business was worth approximately $20 million at the time of Redding's death. Redding's heirs believe the IRS valuation is too high and have hired you to perform a separate valuation analysis in hopes of supporting their position. a. Estimate the firm FCFs for 2015 to 2019, where the firm's tax rate is 25, capital expenditures are assumed to equal depreciation expense, and there are no changes in net working capital over the period. b. Value BBFM using the traditional WACC model and the following information: 1. BBFM's cost of equity is estimated to be 20% and the cost of debt is 10%. 2. BBFM's management targets its long-term debt ratio at 10% of enterprise value. 3. After 2019, the long-term growth rate in the firm's free cash flow will be 5% per year. B PROBLEM 9-5 Given 0.25 Dporate tax rate eper (2010-2014) equals depreciation expense ost of debt financing equired retum on equity arged debt to value ratio Terminal period growth rate in FCFS 0.1 0.2 0.1 0.05 2019 4833125 Base Year 2014 3417500 Income Statement Forecast 2015 2016 2017 2018 3700625 3983750 4266875 4550000 542077 1408113 1.590,983 50 105874 25 1.141,301.13 1.172128.00 TITTEE 126.876205 1.412487361,630.010.13 5.110.00 10:00 5.110 00 136640163290 9151058 1044100 Depreciation COGS Other Operating Expenses EBIT interest Eaming before the Income Tax Net Income Pratened Stock Dividends Nincome to Common Stock Common Stock Dividends Income to Rata ined Eamings 703. 1400 10 24.00 OB0.33.02 On 03.02 1.224,001.10 Base Year 2014 2015 2019 Balance Sheet Current Assets Gros Fond Assets Acumulated Depilation Net Food Assets Total Assets Forecast 2016 2017 OTO 3475 03.07.2 1.350,195 BE 2018 500.00 4080 Cum Labs LT Debi Perrad Stock Common Stoo Metanet Eamine Total Common Equity TotalList Euty 1 2 3 1000 458900 459900 640645 1000 458900 459900 655046.25 1000 458900 459900 669202.5 1000 458900 459900 683358.75 1000 458900 459900 697515 68500 458900 527400 786671.25 45 46 Solution Emate femre cash flows for 2014-2019 Opening home Le Town 2015 2016 TOS 100.00 1502020 51.100.00 Labilities t ad Stock on Stock ed Eamings Common Equity Liablities & Equity 1000 458900 459900 640645 1000 458900 459900 655046.25 1000 458900 459900 669202.5 1000 458900 459900 683358.75 1000 458900 459900 697515 68500 458900 527400 786671.25 Solution Stimate firm free cash flows for 2014-2019 2015 2016 2017 2018 2019 Operating Income Taxes : Depreciation 55: Capex ass Change in NWC im Free Cash Flow (FCF) Value BBFM using the traditional WACC method Calculating the WACC Required Return Debt Equity A/Tx Cost Weight Product Calculating the Enterprise Value of the Firm Planning Panod Terminal Value (and of year 4) PV of Terminal Value Enterprise Value Discussion oblem 0-13 Problem 0-5 Problem - Problem Problem Ready MacBook Air 9-5 Traditional WACC Valuation The owner of Big Boy Flea Market (BBFM), Lewis Redding, passed away on December 30, 2014. His 100% ownership interest in BBFM became part of his estate, on which his heirs must pay estate taxes. The IRS has hired a valuation expert, who has submitted a report stating that the business was worth approximately $20 million at the time of Redding's death. Redding's heirs believe the IRS valuation is too high and have hired you to perform a separate valuation analysis in hopes of supporting their position. a. Estimate the firm FCFs for 2015 to 2019, where the firm's tax rate is 25, capital expenditures are assumed to equal depreciation expense, and there are no changes in net working capital over the period. b. Value BBFM using the traditional WACC model and the following information: 1. BBFM's cost of equity is estimated to be 20% and the cost of debt is 10%. 2. BBFM's management targets its long-term debt ratio at 10% of enterprise value. 3. After 2019, the long-term growth rate in the firm's free cash flow will be 5% per year. B PROBLEM 9-5 Given 0.25 Dporate tax rate eper (2010-2014) equals depreciation expense ost of debt financing equired retum on equity arged debt to value ratio Terminal period growth rate in FCFS 0.1 0.2 0.1 0.05 2019 4833125 Base Year 2014 3417500 Income Statement Forecast 2015 2016 2017 2018 3700625 3983750 4266875 4550000 542077 1408113 1.590,983 50 105874 25 1.141,301.13 1.172128.00 TITTEE 126.876205 1.412487361,630.010.13 5.110.00 10:00 5.110 00 136640163290 9151058 1044100 Depreciation COGS Other Operating Expenses EBIT interest Eaming before the Income Tax Net Income Pratened Stock Dividends Nincome to Common Stock Common Stock Dividends Income to Rata ined Eamings 703. 1400 10 24.00 OB0.33.02 On 03.02 1.224,001.10 Base Year 2014 2015 2019 Balance Sheet Current Assets Gros Fond Assets Acumulated Depilation Net Food Assets Total Assets Forecast 2016 2017 OTO 3475 03.07.2 1.350,195 BE 2018 500.00 4080 Cum Labs LT Debi Perrad Stock Common Stoo Metanet Eamine Total Common Equity TotalList Euty 1 2 3 1000 458900 459900 640645 1000 458900 459900 655046.25 1000 458900 459900 669202.5 1000 458900 459900 683358.75 1000 458900 459900 697515 68500 458900 527400 786671.25 45 46 Solution Emate femre cash flows for 2014-2019 Opening home Le Town 2015 2016 TOS 100.00 1502020 51.100.00 Labilities t ad Stock on Stock ed Eamings Common Equity Liablities & Equity 1000 458900 459900 640645 1000 458900 459900 655046.25 1000 458900 459900 669202.5 1000 458900 459900 683358.75 1000 458900 459900 697515 68500 458900 527400 786671.25 Solution Stimate firm free cash flows for 2014-2019 2015 2016 2017 2018 2019 Operating Income Taxes : Depreciation 55: Capex ass Change in NWC im Free Cash Flow (FCF) Value BBFM using the traditional WACC method Calculating the WACC Required Return Debt Equity A/Tx Cost Weight Product Calculating the Enterprise Value of the Firm Planning Panod Terminal Value (and of year 4) PV of Terminal Value Enterprise Value Discussion oblem 0-13 Problem 0-5 Problem - Problem Problem Ready MacBook Air