The SoftTec Products Company is a successful, small, rapidly growing, closely he
ID: 2773701 • Letter: T
Question
The SoftTec Products Company is a successful, small, rapidly growing, closely held corporation. The equity owners are considering selling the firm to an outside buyer and want to estimate the value of the firm. Following is last year's income statement (2010) and projected income statements for the next four years (2011-2014). Sales are expected to grow at an annual 7 percent rate beginning in 2015 and continuing thereafter. Selected balance sheet accounts at the end of 2010 were as follows. Net fixed assets were $50,000. The sum of the required cash, accounts receivable, and inventories accounts was $50,000. Accounts payable and accruals totaled $25,000. Each of these balance sheet accounts was expected to grow with sales over time. No changes in interest-bearing debt were projected, and there were no plans to issue additional shares of common stock. There are currently 10,000 shares of common stock outstanding. Data have been gathered for a comparable publicly traded firm in the same industry that Soft-Tec operates in. The cost of common equity for this other firm, Wakefield Products, was estimated to be 25 percent. SoftTec has survived for a period of years. Management is not currently contemplating a major financial structure change and believes a single discount rate is appropriate for discounting all cash flows. Project SoftTec's income statement for 2015. Determine the annual increases in required net working capital and capital expenditures (CAPEX) for SoftTec for the years 2011 to 2015. Project annual operating free cash flows for the years 2011 to 2015. Estimate SoftTec s terminal value cash flow at the end of 2014. Estimate SoftTec's equity value in dollars and per share at the end of 2010. SoftTec's management was wondering what the firm's equity value (dollar amount and on a per-share basis) would be if the cost of equity capital were only 20 percent. Recalculate the firm's value using this lower discount rate. Now assume that the $35,000 in long-term debt (and therefore interest expense at 10 percent) is expected to grow with sales. Recalculate the equity using the original 25 percent discount rate.Explanation / Answer
(‘A)- Projected Income Statement of SoftTec for the year 2015
Particulars
2015
Remarks/ Calculation
Net Sales
374.50
(350 x 1.07)
Cost of goods sold
(187.25)
50 % of sales
Gross Profit
187.25
SG & A Expenses
(74.90)
20 % of sales
Depreciation
(18.73)
5 % of sales
Earnings before interest and tax
93.63
Interest
3.5
Fixed
Earnings before tax
90.13
Tax @ 40 %
36.05
Net Income
54.08
(‘B) Annual Increase in Capex and Net Working Capital during the year 2011 to 2015
Particular
2010
Remarks
2011
2012
2013
2014
2015
Net Sales
150
200
250
300
350
374.50
Net Fixed Assets
50
1/3rd of sales
66.67
83.33
100.00
116.67
124.83
Net Annual Increase in CAPEX
16.67
16.67
16.67
16.67
8.17
Current Assets
50
1/3rd of sales
66.67
83.33
100.00
116.67
124.83
Current Liability
25
1/6th of sales
33.33
41.67
50.00
58.33
62.42
Net Working Capital (CA-CL)
25
33.33
41.67
50.00
58.33
62.42
Annual Increase in Net Working Capital
-
-
8.33
8.33
8.33
8.33
4.08
(‘C) Projected Annual Operating Free Cash Flow for the years 2011- 2015
Particulars
2011
2012
2013
2014
2015
Net Income
27.90
35.40
42.90
50.40
54.08
Add: Depreciation
10
12.50
15
17.50
18.73
Add: Interest (1- Tax Rate)
2.10
2.10
2.10
2.10
2.10
Less: Capital Expenditure
16.67
16.67
16.67
16.67
8.17
Less: Increase in Working Capital
8.33
8.33
8.33
8.33
4.08
Free Cash Flow
15
25
35
45
62.66
(‘D) Terminal Value Cash Flow at the end of 2014
= Free Cash Flow for 2015/ (Cost of Equity – Growth)
= 62.66/(0.25-0.07)
Terminal Value = 348.08
Particulars
2015
Remarks/ Calculation
Net Sales
374.50
(350 x 1.07)
Cost of goods sold
(187.25)
50 % of sales
Gross Profit
187.25
SG & A Expenses
(74.90)
20 % of sales
Depreciation
(18.73)
5 % of sales
Earnings before interest and tax
93.63
Interest
3.5
Fixed
Earnings before tax
90.13
Tax @ 40 %
36.05
Net Income
54.08
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