Using the Discounted Cash Flow method and the formula approach (equation 9.3, p.
ID: 2650848 • Letter: U
Question
Using the Discounted Cash Flow method and the formula approach (equation 9.3, p. 249) of the textbook, calculate the maximum price that should be paid for target company – Tyler Corporation. Here the company has 10 years of supernormal growth and then no growth. (15 pts. for PV of operating cash flows, and 15 pts. for the PV of horizon value.)
Given information re Tyler Corporation (all $ Amounts in Millions):
Ro: Initial Year Revenues: $1,000
n = Number of growth years: 10
m = Net Operating Income Margin 20.0%
T = Tax Rate 40.0%
g = Growth Rate 20.0%
I = Investment Rate 10.0%
k = Cost of Capital 10.0%
h = Calculation Relationship = [(1 + g)/(1 + k)] – 1 0.0909
Explanation / Answer
Expected Expected Present Value Present Value Year Earnings formula Earnings Earnings Formula Earnings 1 E(1+g)^1 144.00 E(1+g)^1/(1+r)^1 130.91 2 E(1+g)^2 172.80 E(1+g)^2/(1+r)^2 142.81 3 E(1+g)^3 207.36 E(1+g)^3/(1+r)^3 155.79 4 E(1+g)^4 248.83 E(1+g)^4/(1+r)^4 169.96 5 E(1+g)^5 298.60 E(1+g)^5/(1+r)^5 185.41 6 E(1+g)^6 358.32 E(1+g)^6/(1+r)^6 202.26 7 E(1+g)^7 429.98 E(1+g)^7/(1+r)^7 220.65 8 E(1+g)^8 515.98 E(1+g)^8/(1+r)^8 240.71 9 E(1+g)^9 619.17 E(1+g)^9/(1+r)^9 262.59 10 E(1+g)^10 743.01 E(1+g)^10/(1+r)^10 286.46 Total 3738.05 1997.54 Earnings = 120 x (1+0.20) Income = Revenue x Operating Margin x (1-Tax Rate) E=Ro(0.20)(1-T) So E=120 So Price = Present Value of all earnings over 10 years = 1997.54
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