You have been retained as a consultant to estimate the value of Cyber Kinetic Systems (CKS), a manufacturer of electronic components. The most recent financial statements for the company are presented below. Similar companies have a cost of capital of 12%. The company is expected to grow at 15% per year for the next five years, after which the growth rate will drop to 5%. CKS is a privately held company.

Income Statement
Revenue	9,500,000
Cost of goods sold	(6,000,000)
SG&A expense	(2,000,000)
Operating income (EBIT)	1,500,000
Interest expense	(300,000)
Earnings before taxes	1,200,000
Taxes	(480,000)
Net income	720,000

Balance Sheet
Assets:
Cash	150,000
Accounts receivable	900,000
Inventory	250,000
Total current assets	1,300,000
Fixed assets, net	6,700,000
Total Assets	8,000,000
Liabilities and Equity:
Accounts payable	400,000
Notes payable	3,000,000
Total liabilities	3,400,000
Common stock	1,000,000
Retained earnings	3,600,000
Total stockholders' equity	4,600,000
Total Liabilities and Equity	8,000,000

Statement of Cash Flows
Cash flow from operating activities:
Net income	720,000
Depreciation	400,000
Decrease (increase) in accounts receivable	(150,000)
Decrease (increase) in inventory	(40,000)
Increase (decrease) in accounts payable	50,000
Total cash flow from operating activities	980,000
Cash flow from investing activities:
Purchase of fixed assets	(600,000)
Total cash flow from investing activities	(600,000)
Cash flow from financing activities:
Payment of dividends	(350,000)
Total cash flow from financing activities	(350,000)
Cash at beginning of period	120,000
Net change in cash	30,000
Cash at end of period	150,000

Base case DCF valuation

Use the financial statements and the assumptions presented above to

1)Calculate the free cash flow that was generated by CKS in the most recent year.

2)Forecast the free cash flow over the next six years.

For the next three questions, use a discounted cash flow (DCF) approach to

3)Estimate the terminal value of the company after five years.

4)Estimate the current enterprise value of the company.

5)Estimate the current value of the companys equity.

Scenario analysis

6)The initial assumptions used a cost of capital of 12%, and a long-term growth rate of 5%. Determine the enterprise value of the company if each of these values are increased or decreased by 1%. In other words, fill in the entries in the table below:

Scenario analysis
		Long-term growth rate
		4%	5%	6%
Cost of capital	11%
	12%
	13%

Valuation using multiples

Assume that public companies in the same industry as CKS currently trade at 6.5 times forecasted EBITDA. Based on this information and the base-case assumptions,

6)Estimate the current enterprise value of the company.

7)Estimate the current value of the companys equity.

8)Effects of a change in operating margin

Return to the base-case assumptions of a 5% long-term growth rate and a 12% cost of capital. Assume that the operating margin of CKS can be increased to 20% in the coming year, and will remain at 20%.

8)Describe how this revised assumption would change your estimate of the enterprise value of CKS using a discounted cash flow method. Would your revised estimate be higher or lower than your base-case estimate in Question 4 above? You do not have to re-calculate enterprise value just explain how it would change.

9)Describe how this revised assumption would change your estimate of the enterprise value of CKS using an EBITDA multiple. Would your revised estimate be higher or lower than your base-case estimate in Question 6 above? You do not have to re-calculate enterprise value just explain how it would change.

Base case DCF valuation (USE THIS TEMPLATE AND ANSWER BELOW)

Calculate the free cash flow that was generated by CKS in the most recent year. (show your work)

FCF₀ =

Forecast the free cash flow over the next six years.

FCF₁ =

FCF₂ =

FCF₃ =

FCF₄ =

FCF₅ =

FCF₆ =

Estimate the terminal value of the company after five years.

TV₅ =

Estimate the current enterprise value of the company.

Response:

Estimate the current value of the companys equity.

Response:

Scenario analysis

Revised estimates of enterprise value:

Scenario analysis
		Long-term growth rate
		4%	5%	6%
Cost of capital	11%
	12%
	13%

Valuation using multiples

Estimate the current enterprise value of the company.

Response:

Estimate the current value of the companys equity.

Response:

Effects of a change in operating margin

Effect of revised operating margin on estimate of enterprise value using a DCF method:

Response:

Effect of revised operating margin on estimate of enterprise value using an EBITDA multiple:

Response: Answer