1. Sequential Valuation – Love Potion Free Cash Flow 1999 = 1,000 –Interest expense = 50 –Depreciation = 100 –R&D = 1,500 –Expenses to remain a constant percent of sales except depreciation –Depreciation to remain $100 forever (perpetuity) Sales Growth (real) –20% for 2 years (non-constant growth period) –10% stabilization (constant growth period) Effective tax rate = 30% Inflation = 3% Real Risk Free Rate = 7% Nominal Discount Rate = 21% What is the value of the firm?

2. Love Potion Continued What is the nominal risk free rate? What is the real risky rate? Are the following cash flows risky or risk free? –Residual FCF –DTS Do they require a nominal or real discount rate? Is Terminal Value based on Cash Flow or an Exit Multiple? What are the Residual Operating Free Cash Flows (net of depreciation tax shield)? –What is the PV of this FCF? What is the Terminal Value? –What is the PV of the Terminal Value? What is the PV of the Depreciation Tax Shield? Is any mid-year (half-year) discounting required?

3. Sequential Valuation Bloomington Organic Pest Control Bloomington Organic Pest control utilizes natural predators to control insects. The process is slow but effective and perfect for Bloomington because no chemicals are involved! The company has started slowly but expects to have high growth for the next 5 years as the Bloomingtonians become more familiar with the company. The firm had free cash flow net of the depreciation tax shield of only $500 last year. BPC’s real growth is expected to double next year and then grow at 50% for two years and 12% for two more years after that. The firm is unsure of its growth rate after 5 years, but considers themselves to be typical of other firms in their industry. Similar firms trade at a P/E multiple of 10 and that is expected to continue indefinitely. The firm has 500 shares of stock and $10,000 in debt outstanding. Inflation is expected to be 4%, the real risk free rate is 2% and their nominal risky rate of return is 13%. The firm had earnings before tax last year of $385 and expects them to grow at the same real rate as net operating FCF. BPC incurred depreciation expense of $100 last year. This amount will remain flat for the next five years. Their tax rate is 35%.