6. Bartling Energy Systems last year (year 0) reported $9,250 of sales, $5,750 o

Question

6. Bartling Energy Systems last year (year 0) reported $9,250 of sales, $5,750 of operating costs other than depreciation, and $700 of depreciation. The company had no amortization charges, it had $3,200 of outstanding bonds that carry a 5% interest rate, and its federal-plus-state income tax rate was 35%. In order to sustain its operations and thus generate sales and cash flows in the future, the firm was required to make $1,250 of capital expenditures on new fixed assets and to invest $300 in net operating working capital (W.?.). This information and some other useful information is provided in following Table 1. Table 1. Estimation Year 0 Ratios Year 1 9250 Growth(sales) Sales Costs Depreciation Tax rate 5750 Cost/Sales 700 0.35 3200 0.05 Bonds Bond rate Required Investments (Gross Values): Fixed Assets 1250 300 Net Booking Values: Fixed Assets W.c. 24500 6000

Explanation / Answer

Part 1)

The operation cash flows and FCF in year 1 is calculated as below:

Operation Cash Flows = (Sales for Year 1 - Operation Costs for Year 1)*(1-Tax Rate) + Depreciation = [9,250*(1+5%) - 5,750*(1+5%)]*(1-35%) + 700 = $3,088.75

FCF in Year 1 = Operation Cash Flows - Change in Capital Expenditure - Change in Working Capital = 3,088.75 - 62.5 - 15 = $3,011.25

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Notes:

1) Changes in capital expenditure and change in working capital is calculated in exact proportion to change in sales.

2) Depreciation is assumed to remain constant at $700 for Year 1.

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Part 2)

The company's market value is calculated as below:

Market Value = Free Cash Flow for Year 1*(1+Growth Rate)/(WACC - Growth Rate) = 3,011.25*(1+3%)/(10.25%-3%) = $42,780.52

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Part 3)

The company's current equity value is arrived as below:

Company's Current Equity Value = Total Market Value of the Company - Total Value of Debt = 42,780.52 - 3,200 = $39,580.52

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Part 4)

We will have to calculate the revised FCF as below:

Revised FCF = (Sales for Year 1 - Operating Costs for Year 1)*(1-Tax Rate) + Depreciation - Change in Capital Expenditure - Change in Working Capital = [9,250*(1+5%) - 9,250*(1+5%)*(5,750/9,250 -5%))]*(1-35%) + 700 - 62.5 - 15 = $3,326.91

Revised Market Value = Free Cash Flow for Year 1*(1+Growth Rate)/(WACC - Growth Rate) = 3,326.91*(1+3%)/(10.25%-3%) = $47,265.07

Change in Market Value = 47,265.07 - 42,780.52 = $4,484.55

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