Terminal value refers to the valuation attached to the end of the planning perio

Question

Terminal value refers to the valuation attached to the end of the planning period; it captures the value of all subsequent cash flows. Estimate the value today for each of the following sets of future cash flow forecasts.

a.Claymore Mining Company anticipates that it will earn firm FCFs of $4 million per year for each of the next five years. Beginning in year 6, the firm will earn FCF of $5 million per year for the indefinite future. If Claymore’s cost of capital is 10%, what is the value of the firm’s future cash flows?

b.Shameless Commerce Inc. has no outstanding debt and is being evaluated as a possible acquisition. Shameless’s FCFs for the next five years are projected to be $1 million per year, and, beginning in year 6, the cash flows are expected to begin growing at the anticipated rate of inflation, which is currently 3% per annum. If the cost of capital for Shameless is 10%, what is your estimate of the present value of the FCFs?

c.Dustin Electric Inc. is about to be acquired by the firm’s management from the firm’s founder for $15 million in cash. The purchase price will be financed with $10 million in notes that are to be repaid in $2 million increments over the next five years. At the end of this five-year period, the firm will have no remaining debt. The FCFs are expected to be $3 million a year for the next five years. Beginning in year 6, the FCFs are expected to grow at a rate of 2% per year into the indefinite future. If the unlevered cost of equity for Dustin is approximately 15% and the firm’s borrowing rate on the buyout debt is 10% (before taxes at a rate of 30%), what is your estimate of the value of the firm?

Please use below template for solution:

PROBLEM 9-9 a. Claymore Mining Company Given Unlevered Cost of Capital 10.00% Year 1 2 3 4 5 6+ FCF $ 4,000,000.00 $ 4,000,000.00 $ 4,000,000.00 $    4,000,000.00 $ 4,000,000.00 $ 5,000,000.00 Solution Present value of free cash flows: Planning period Terminal value Enterprise Value b. Shameless Commerce, Inc. Given Unlevered Cost of Capital 10.00% growth rate in terminal cash flows 3.00% Year 1 2 3 4 5 6+ FCF $ 1,000,000.00 $ 1,000,000.00 $ 1,000,000.00 $    1,000,000.00 $ 1,000,000.00 $ 1,030,000.00 Solution Valuing the unlevered cash flows Planning period Terminal value Enterprise Value c. Dustin Electric, Inc. Given K-WACC (Cost of capital) 10.00% growth rate in terminal cash flows 2.00% Corporate tax rate                  0.30 Cost of debt                  0.10 Unlevered cost of equity 15.00% Solution Year 0 1 2 3 4 5 6+ FCF $ 3,000,000.00 $ 3,000,000.00 $    3,000,000.00 $ 3,000,000.00 $ 3,000,000.00 Debt $10,000,000.00 Interest Tax shields After-tax interest debt principal paid Equity FCF Valuing the unlevered cash flows Planning period Terminal value Valuing the interest tax savings Planning period Terminal value Enterprise Value = Value of the unlevered firm + Value of interest tax savings Less: Debt (at time 0) Equity Value

Explanation / Answer

a) claymore mining company 1 2 3 4 5 6+ free cash flows 4000000 4000000 4000000 4000000 4000000 50000000 pvifa @ 10% 0.9091 0.8264 0.7513 0.6830 0.6209 0.6209 present value of free CFs: Planning period 3636364 3305785 3005259 2732054 2483685 Terminal value 31045000 Enterprise value 46208147 b) Shameless commerce inc FCF 1000000 1000000 1000000 1000000 1000000 14714286 pvifa @ 10% 0.9091 0.8264 0.7513 0.6830 0.6209 0.6209 present value of free CFs: Planning period 909091 826446 751315 683013 620921 Terminal value 9136100 Enterprise value 12926887 c) Dustin electric Inc FCF 3000000 3000000 3000000 3000000 3000000 23538462 debt - beginning balance 10000000 8000000 6000000 4000000 2000000 interest 1000000 800000 600000 400000 200000 tax shields 300000 240000 180000 120000 60000 0 after tax interest 700000 560000 420000 280000 140000 debt principal paid 2000000 2000000 2000000 2000000 2000000 Equity FCF 300000 440000 580000 720000 860000 Valuing the unlevered cash flows pvif @ 15% 0.8696 0.7561 0.6575 0.5718 0.4972 0.4972 planning period 2608696 2268431 1972549 1715260 1491530 10056465 terminal value 11703323 valuing the interest tax shields: pvif @ 10% 0.9091 0.8264 0.7513 0.6830 0.6209 0.6209 planning period 272727 198347 135237 81962 37255 725528 terminal value 0 Enterprise value = 21759788+725528= 22485316 Debt at time = 0 10000000 Equity value 12485316

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