You are a financial analyst at Berkeley Capital, a major investment banking firm. Your supervisor has just handed you a difficult assignment. You must review the work of an intern, who after given the pro forma income statement and pro forma balance sheet was asked to prepare a valuation. This intern is known to make at least 10 mistakes on each valuation attempted. Your boss wants you to identify those specific errors, suggest how they should have been done but do NOT calculate the correction, nor challenge the assumptions underlying the pro forma statements.

RedRock is interested in buying Flirter, a private firm. They have asked Berkeley Capital to conduct a valuation of Flirter. Flirter has had high growth but not profit. Berkeley Capital believes a tax rate of 25% would be appropriate. It is the firm's policy apply a 7 times multiple of EBITDA in calculating terminal value for FCF. The terminal value of tax savings is calculated using a 6 times multiple method. A 10% liquidity discount is applied to acquisitions of private firms. Long term growth after the initial five year period is assumed to be 11%. Currently, Flirter pays a 8% interest rate on its debt. Flirter does not pay a dividend. Econometric studies suggest the current risk free rate is 1%, while the market risk premium is 5%.

Scoring: Correctly identifying error credit, proper correction credit (remember you do not calculate the correction), misidentifying error credit. Note that rounding is NOT an error. Each error is worth 4.5 points up to a total of 45 points.

Exhibit 1: Pro Forma Income Statement

	Yr 1	Yr 2	Yr 3	Yr 4	Yr 5
Gross Sales	728	946	1183	1479	1775
Cost of Sales	255	331	413	518	621
Gross Profit	473	615	770	961	1154
SGA (Incl.R&D)	584	613	644	676	709
Depr	33	35	38	42	50
Operating Income	-144	-33	88	243	395
Interestexpense	33	33	33	33	33
Taxes	-44	-17	14	53	91
Net Income	-133	-49	41	157	271

Exhibit 2: Pro Forma Balance Sheet (Millions)

	0	1	2	3	4	5
Cash	2234	2140	2089	2116	2140	2317
NWC	343	287	236	220	235	249
PPE	789	806	859	889	1007	1087
Debt	416	416	416	416	416	416
Equity	2950	2817	2768	2809	2966	3237

Exhibit 3: Information from Comparable Companies& Beta Calculations

	Sales (millions)	Tax Rate	D/E	Levered Beta	Unlevered Beta Calculated
Zitter	763	0.250	.14	1.20	1.08
Mindbook	12446	0.400	.07	0.85	0.82
Doddle	66001	0.200	.10	1.07	0.99
YuHuu	4680	0.250	.24	1.10	0.93
Average		0.280			0.96

Exhibit 4: Cost of Equity Calculation

1% +.96 * (5-2)% = 4.88%

Exhibit 5: Debt

Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 Beg Debt 416 416 416 416 416 Payments End Debt 416 416 416 416 416

Exhibit 6: Subsidiary Schedules

		1	2	3	4	5
Depreciation Calculation
EBITDA		-111	32	126	285	445
-EBIT		-144	-3	88	243	395
Depreciation		33	35	38	42	50
Cap Ex Calculation
Beg Net PPE		786	806	824	854	934
End Net PPE		806	824	854	934	1014
Depreciation		33	35	38	42	50
CapEx		53	53	68	122	130
FCF/DCF Calculation
EBIT		-144	-3	88	243	395
-Interest		33	33	33	33	33
+Tax		-36	-1	22	61	99
-CapEx		53	53	68	122	130
+Chg NWC		287	236	220	235	249
FCF		21	146	229	384	580
Terminal Value						2765
DIscount Factor		1.0	.953	.909	.867	.826
DCF (inclTV 2765)	3945	21	139	208	333	479
Tax Shield Cash Flow Calculation
Interest Expense		33	33	33	33	33
Interest Tax Shield		8	8	8	8	8
TV						48
Present Value Factor		.953	.909	.867	.826	.787
PV (incl. TV*1.269)	96	7.6	7.3	6.9	6.3	60.9
+Liquidity Discount	395
Enterprise Value	4436
-(Debt +Cash)	2556
Equity Value	1880