Gemco Jewelers earned $5 million in after-tax operating income in the most recen
ID: 2790461 • Letter: G
Question
Gemco Jewelers earned $5 million in after-tax operating income in the most recent year. The firm also had capital expenditures of $4 million and depreciation of $2 million during the year, and the non-cash working capital at the end of the year was $10 million.
(a) Assuming that the firm’s operating income will grow 20% next year, and that all other items (capital expenditures, depreciation, and non-cash working capital) will grow at the same rate, estimate the FCFF next year.
(b) If the firm can grow at 20% for the next five years, estimate the present value of the FCFF over that period. Assume a cost of capital of 12%.
(c) After year 5, the growth rate will drop to 5% forever. In year 6, the firm’s capital expenditures will be 6.53m, and operating income, non-cash working capital and depreciation will be 5% higher than in year 5. In addition, the cost of capital will decline to 10%. Estimate the terminal value of the firm at the end of year five.
(d) Estimate the current value of the operating assets of the firm.
Explanation / Answer
a)
Operating cashflow = Operating income + depreciation = 5 + 2 = 7
FCFF = Operating cashflow - capital expenditure - change in working capital
Next year Operating cashflow = 7*(1+20%) = 8.4
capital expenditure = 4*(1+20%) = 4.8
change in working capital = 10*(1+20%) - 10 = 2
FCFF = 8.4 - 4.8 - 2 = 1.6 million
b)
PV of FCFF = 1.6 / (1+12%) + 1.6*(1+20%) / (1+12%)2 + 1.6*(1+20%)2 / (1+12%)3 + 1.6*(1+20%)3 / (1+12%)4 + 1.6*(1+20%)4 / (1+12%)5
= 8.238792
c)
Terminal value = FCFF*(1+g) / (r-g)
= 1.6*(1+20%)4 * (1+5%) / (10%-5%) = 69.6730
d)
Current value = PV of FCFF + PV of terminal
= 8.238792 + 69.6730 / (1+12%)5
= 47.8287
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