Teton Valley CaseFree Cash Flows

Free Cash Flow For each future year you want to calculate: FCF = EBIT(1 – Tc) (no debt tax shields calculated)

+ Depr & Amort. (adjust for non-cash

expenses)

- Capital Expenditures (a cash flow not

part of EBIT)

- Changes in NWC (almost, to adjust for accruals.)

Teton Valley Corporation Sales growth at 10% for 5 years then 4% in

perpetuity. CGS at 65% of sales. SGA at $500,000 + 4.5% of sales. Net Fixed assets grow at 5% per year for next 5 years. Depreciation is 20% of beginning of year net fixed

assets. NWC is $80,000, grows with sales. FCFs grow at 4% in perpetuity after 2011.

Forecasting EarningsTETON VALLEY CORPORATION

VALUATION(See Valuation; LectureMod#19) 2007 2007 2008 2008

NET FIXED ASSETS GROW AT 5% $750,000(1.05) 787,500$ (C5 (1.05)) 826,875$ (From base of $750,000)

(1) SALES (10% growth from $5.5M) $5,500,000(1.1) 6,050,000$ C8 * 1.1 6,655,000$ (2) COST OF GOODS SOLD (0.65 of sales) (B8 * 0.65) 3,932,500$ (D8 * 0.65) 4,325,750$ (3) GROSS MARGIN (1 - 2) (B8 - B9) 2,117,500$ (D8 - D9) 2,329,250$ (4) GSA ($500,000 + 4.5% of sales) $500,000+B8*.045 772,250$ $500,000+D8*0.45 799,475$ (5) DEPRECIATION (20% of prev yr NFA) $750,000(.20) 150,000$ $787,500(.20) 157,500$ (6) EBIT (3 - 4 - 5) (B10 - B11 - B12) 1,195,250$ (D10 - D11 - D12) 1,372,275$ (7) INTEREST (DO NOT INCLUDE!) finance cost -$ finance cost -$ (8) EBT (just 6 - "assume its an all equity firm") B13 1,195,250$ D13 1,372,275$ (9) TAX (8 *Tc) B13 * 0.30 (358,575)$ D13 * 0.30 (411,683)$ (10) EAT (8*(1-Tc) or 8 - 9) B13 * 0.70 836,675$ D13 * 0.70 960,593$

The Pro Forma Exercise For a complete pro forma analysis we also

need to forecast the balance sheet. Two issues for this example:

1. The balance sheet is so simple it is a trivial exercise.

2. We need to make some assumptions. About what?

Forecasting the Balance Sheet

What did I assume? Are there any issues? Complete the forecast on the spreadsheet.

Balance Sheet 2007 2008Assets Liabilities Assets Liabilities

Current Assets 275000 Non-Int Bearing Liab 187000 Current Assets 302500 Non-Int Bearing Liab 205700Net Fixed Assets 787500 Interest Bearing Liab 395500 Net Fixed Assets 826875 Interest Bearing Liab 443675

Equity 480000 Equity 480000Total Assets 1062500 Total Liab+ Equity 1062500 Total Assets 1129375 Total Liab+ Equity 1129375

From Earnings To Free Cash Flow

(10) EBIT(1-Tc): (8*(1-Tc) or 8 - 9) B13 * 0.70 836,675$ D13 * 0.70 960,593$

(11) + DEPRECIATION (5) B12 150,000$ D12 157,500$

(12) OPERATING CASH FLOW (10 + 11) B17 + B19 986,675$ D17 + D19 1,118,093$

(13) - Change in Net W/C (grows at 10%) $80,000 * 0.10 8,000$ C23 *1.1 8,800$ (14) -CAPITAL EXPENDITURE B5 - 750k + B12 187,500$ D5 - C5 + D12 196,875$ (change in NFAs + depr = change in gross FA)(15) FREE CASH FLOW (FCF=12-13-14) B21 - B23 - B24 791,175$ D21 - D23 - D24 912,418$

FCF = EBIT(1-Tc) + Depr. - ∆NWC – Cap Ex.

So: 2007 2007 2008 2008

2007 2008 2009 2010 2011FCF: 791,175 912,418 1,046,141 1,193,610 1,356,219

Free Cash Flow We start with earnings before interest and

taxes. Why? Before interest because financing costs should not

be taken out and we are supposing its an all equity firm.

Before taxes to make it easier to ignore the debt tax shields that will be included if you use actual taxes paid or provision for income taxes.

Why is it almost -NWC? Recall there are two reasons:

1st – one of the NWC accounts is the current portion of long term debt. We leave out changes in the current portion of long term debt from cash flow since this is a financing cash flow.

2nd – a level of the cash account is necessary only up to a balance required for liquidity. Increases in the cash account above this minimum could be paid out as dividends or used to pay down principal without reducing the effectiveness of the firm going forward. Thus increases in cash above the minimum are not to be subtracted to find FCF so should not be counted in the change to NWC.