1. A firm which does not pay dividends can be valued by discounting all its FREE CASH FLOWS by its WACC
Free Cash Flows = the cash flows actually available for distribution to investors after the company has made all the new products, and working capital necessary to sustain ongoing operations
Free Cash Flows = NOPAT – Net Investment in Operating Capital
NOPAT = The Net Profit that a company would generate if it had no debt and held no non-operating assets
NOPAT = EBIT (1-Tax Rate)
Net Investment in Operating Capital = Change in Operating Capital

2. Operating Capital = Net Fixed Assets + Net Operating Working Capital
Net Operating Working Capital = the working capital acquired with investor-supplied funds i.e.
Current Assets – (Accounts Payable + Accruals)

3. Balance Sheet: Assets
2000
1999
Cash
7,282
57,600 AR
632,160
351,200
Inventories
1,287,360
715,200
Total CA
1,926,802
1,124,000
Gross FA
1,202,950
491,000
Less: Deprec.
263,160
146,200
Net FA
939,790
344,800
Total Assets
2,866,592
1,468,800

4. Liabilities and Equity
2000
1999
Accts payable
524,160
145,600
Notes payable
720,000
200,000
Accruals
489,600
136,000
Total CL
1,733,760
481,600
Long-term debt
1,000,000
323,432
Common stock
460,000
460,000
Retained earnings
(327,168)
203,768
Total equity
132,832
663,768
Total L&E
2,866,592
1,468,800

5. Income Statement
2000
1999
Sales
5,834,400
3,432,000
COGS
5,728,000
2,864,000
Other expenses
680,000
340,000
EBITDA
(573,600)
228,000
Depr. & Amort.
116,960
18,900
EBIT
(690,560)
209,100
Interest exp.
176,000
62,500
EBT
(866,560)
146,600
Taxes (40%)
(346,624)
58,640
Net income
(519,936)
87,960

6. What was the free cash flow (FCF) for 2000?
FCF = NOPAT – Net investment in Operating Capital
= -$414,336 – ($1,852,832 – 1,187,200)
= -$414,336 – $665,632
= -$1,079,968.

7. net operating profit after taxes (NOPAT)?
NOPAT = EBIT(1 – Tax rate)
NOPAT00 = -$690,560(1 – 0.4)
= -$690,560(0.6)
= -$414,336.

8. Operating Capital
Operating
capital
= Net fixed assets + NOWC
= $939,790 + $913,042
= $1,852,832.
= $1,187,200.
Operating
capital00
Operating
capital99

9. Issues Regarding the Free Cash Flow Method
Free cash flow method is often preferred to the dividend growth model--particularly for the large number of companies that don’t pay a dividend, or for whom it is hard to forecast dividends.
(More...)

10. FCF Method Issues Continued
Similar to the dividend growth model, the free cash flow method generally assumes that at some point in time, the growth rate in free cash flow will become constant.
Terminal value represents the value of the firm at the point in which growth becomes constant.

11. FCF estimates for the next 3 years are -$5, $10, and $20 million, after which the FCF is expected to grow at 6%. The overall firm cost of capital is 10%. 1 2 3 4
k = 10%
...
g = 6%
-4.545
8.264
15.026
21.20
0.04
530 = = *TV3
*TV3 represents the terminal value of the firm, at t = 3.

12. The firm’s value would therefore be$