1. Exhibit 12.13 presents free cash flow and economic-profit forecasts for ApparelCo, a $250 million company that produces men’s clothing. ApparelCo is expected to grow revenues, operating profits, and free cash flow at 6 percent per year indefinitely. The company earns a return on new invested capital (RONIC) of 15 percent. The company’s cost of capital is 10 percent.

Using the key value driver formula, what is the continuing value as of year 5? Using discounted-cash-flow analysis, what is the value of operations for ApparelCo? What percentage of ApparelCo’s total operating value is attributable to the continuing value?

EXHIBIT 12.13 ApparelCo: Free Cash Flows and Economic Profit

$ million Today Year 1 Year 2 Year 3 Year 4 Year 5 Continuing value Key value drivers, %

Revenues 250.0 265.0 280.9 297.8 315.6 334.6 354.6 Operating costs (225.0) (238.5) (252.8) (268.0) (284.1) (301.1) (319.2)

Return on new invested capital 15 Operating margin 25.0 26.5 28.1 29.8 31.6 33.5 35.5 Growth rate 6 Operating taxes 25 Operating taxes (6.3) (6.6) (7.0) (7.4) (7.9) (8.4) (8.9) Cost of capital 10 NOPLAT 18.8 19.9 21.1 22.3 23.7 25.1 26.6 Net investment (7.5) (8.0) (8.4) (8.9) (9.5) (10.0)

Free cash flow 11.3 11.9 12.6 13.4 14.2 15.1 Economic profit NOPLAT 19.9 21.1 22.3 23.7 25.1 26.6 Invested capitalt–1 132.5 140.5 148.9 157.8 167.3 177.3 Cost of capital, % 10.0 10.0 10.0 10.0 10.0 10.0 Capital charge 13.3 14.0 14.9 15.8 16.7 17.7 Economic profit 6.6 7.0 7.4 7.9 8.4 8.9