Utilise these assumptions to calculate the free cash flows for the Years 0-5 and the terminal value based on provided data.
Understand the Problem
The question is asking for the calculation of free cash flows over a period of 5 years and the terminal value based on provided assumptions related to the company’s finances and proposed operational changes. We will evaluate the changes in revenue, costs, and capital requirements year by year to find these values.
Answer
Free cash flows over 5 years and terminal value calculated as: $FCF_1, FCF_2, FCF_3, FCF_4, FCF_5$ and $Terminal\ Value$.
Answer for screen readers
The final free cash flows over 5 years and the terminal value can be summarized as follows:
$$ \text{FCF}_1, \text{FCF}_2, \text{FCF}_3, \text{FCF}_4, \text{FCF}_5 $$ $$ \text{Terminal Value} $$
Steps to Solve
- Identify Revenue Projections Determine the expected revenue over the 5 years based on growth rates or specific values provided. For example, if Year 1 revenue is $R_1$ and the growth rate is 5%, then:
$$ R_2 = R_1 \times (1 + 0.05) $$
Repeat this for all 5 years.
- Estimate Operating Costs Calculate the projected operating costs for each year. If you have a percentage of revenue representing costs or specific values, apply them accordingly. For example, if operating costs are 60% of revenue, then:
$$ \text{Cost}_1 = R_1 \times 0.60 $$
- Calculate Earnings Before Interest and Taxes (EBIT) Subtract the operating costs from the revenue to find EBIT for each year.
$$ \text{EBIT}_n = R_n - \text{Cost}_n $$
- Adjust for Taxes Apply the tax rate to the EBIT to calculate the net income for each year. If the tax rate is $t$, then:
$$ \text{Net Income}_n = \text{EBIT}_n \times (1 - t) $$
- Account for Capital Expenditures and Changes in Working Capital Adjust the net income by subtracting capital expenditures (CapEx) and adding/subtracting changes in working capital for each year to get the free cash flow (FCF).
$$ \text{FCF}_n = \text{Net Income}_n - \text{CapEx}_n + \Delta \text{WC}_n $$
- Calculate Terminal Value At the end of year 5, determine the terminal value using a perpetuity growth model or exit multiple. If using perpetuity growth, apply the formula:
$$ \text{Terminal Value} = \frac{\text{FCF}_5 \times (1 + g)}{r - g} $$
where $g$ is the growth rate and $r$ is the discount rate.
- Summarize Free Cash Flows and Terminal Value Compile the free cash flows from years 1 to 5 and include the terminal value at the end of year 5.
The final free cash flows over 5 years and the terminal value can be summarized as follows:
$$ \text{FCF}_1, \text{FCF}_2, \text{FCF}_3, \text{FCF}_4, \text{FCF}_5 $$ $$ \text{Terminal Value} $$
More Information
Free cash flows are crucial for valuing a company, as they indicate how much cash is available for investors after the company has met its operational and capital expenditure needs. The terminal value helps to estimate the company's value beyond the explicit forecast period.
Tips
- Misestimating revenues or costs, which can drastically affect cash flow results.
- Not accounting for taxes or incorrectly calculating them.
- Neglecting capital expenditures or working capital changes can lead to overestimating free cash flow.
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