The goal of this analysis is to determine a financial valuation of the fair market value of 100% of The Duke’s Sporting Goods Store (“Duke’s”), by using two of the three approaches to valuation. The valuation date is December 31 of the current year.
The following Excel file containing two spreadsheets: Duke’s Discounted Cash Flow Analysis and Market Approach.
Data have been entered in these spreadsheets that will allow you to calculate valuations for Duke’s under the income and market approaches.
FACTS
The company’s assets are cash ($100,000), inventory (worth $400,000 based on cost), and accounts receivable ($25,000).
Inventory can be sold back to manufacturers for 50% of its cost.
Accounts receivable can be sold to a collections agency for 40% of its current level.
The company’s liabilities are accounts payable of $75,000 and accrued expenses of $75,000.
The Discounted Cash Flow Analysis spreadsheet shows the most recent three years’ incomestatements in simplified form.
Assume the company pays a corporate tax rate of 40%.
For the current year, depreciation and amortization is $25,000. The company is using straight-linedepreciation. Thus, D&A is expected to be $25,000 going forward.
The physical depreciation and/or amortization of fixed assets is allowed to be booked as an expense,thus lowering the taxable income. Yet, it is not an actual decrease in dollars so it is not a decrease in cash flow. That is why it is added back in to Net Income on the way to calculating Net Cash Flow. Net Cash Flow is actual physical dollars coming out of the business during the time period.
There is no interest expense.
For the current year, capital expenditures (CAPEX) is $50,000. CAPEX refers to the currentexpenditure of money by the company to purchase equipment and other assets that will help the company earn more money in the future. It directly affects net cash flow because it is spent in the current year instead of being passed through to the owners (as NCF).
ASSUMPTIONS
Assume the discount rate is 16% (based on comparables collected from Ibbotson’s database and other adjustments for risk).
Assume that the perpetual growth rate of net cash flow is 3.5% for the terminal year and beyond (the terminal year is the fourth year out from the current year, and it represents every year thereafter, adjusted for the perpetual growth rate).
Assume CAPEX is constant over the relevant time periods because the company is consistently and constantly investing in its future.
Assume D&A will continue to be $25,000 per year, given that the equipment and capital expenditures are being used to obtain fixed assets that are depreciable.
INCOME APPROACH
1. Forecast. Use the Discounted Cash Flow Analysis spreadsheet provided by your instructor and forecast revenues and expenses for Current Year + 1 (CY+1), CY+2, CY+3, and Terminal Year. For this case study, use only the previous years’ revenues and expenses as a guide. (Normally, you would also use other information about the economy, the industry, the company, and so forth). Come up with your own reasonable forecast.
Net income. Calculate the net income for CY+1, CY+2, CY+3, and terminal year.
Net cash flow. Calculate the net cash flow for CY+1, CY+2, CY+3, and terminal year.
Calculate NCF from net income.
Start with net income and add back depreciation and amortization to find gross cash flow.
Subtract CAPEX from gross cash flow.
Subtract any increase (or add any decrease) in net working capital. To calculate changes in NWC, subtract current liabilitiesfrom current assets (not including inventory, since, even though inventory is technically a current asset, a manager would notwant to rely on inventory to pay workers). Make a reasonable assumption for changes in NWC for future years.
The result is net cash flow.
Net present value. Calculate the NPV of Duke’s.
Determine the discount period for each year (CY and going forward).
Determine the discount factor for each year, including the terminal year.
Enter the discount rate and perpetual growth rate in the spreadsheet.
Calculate the terminal value.
Calculate the present value of the NCF for each year, including the terminal year.
Add up each year’s present value to find the net present value of the entire business, based on cash flow.