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Dear Sir,
I am working on the question Pursuit Co. The question mentioned sales revenue will grow at the same average rate as the previous years, but no information for the growth rate for operating profit. How can we get 6% growth rate in the solution?
THanks,We know that the sales revenue has been growing at 6%, and in the absence of any more information we have no choice but to assume that the operating profit will grow initially at 6% as well (especially since the question does say that in later years the growth in operating profit will fall to have that of the growth in sales revenue).
It is an assumption (but the only logical assumption on the information available) and is mentioned as a limitation in within the report.
The capital structure part, they want to maintain 50/50.
And why would they need more borrowing when the cash reserves are 20 million.But if you read the answer carefully you will see that they will need to pay just over $49M. The only have $20M in cash and so they will have to get the rest from borrowing.
Hi John, I don’t understand where the 0.03 growth for fodder, and 0.029 growth for the combined entity, figures come from in the solution below.
Thanks, MeabhFodder Co cash flow and value computation ($000)
Year 1 2 3 4
Sales revenue 17,115 18,142 19,231 20,385
Operating profit 5,477 5,805 6,154 6,523
Less tax (28%) (1,534) (1,625) (1,723) (1,826)
Less additional investment (22c/$1 of sales revenue increase)
(213) (226) (240) (254)
Free cash flows 3,730 3,954 4,191 4,443
PV (13%) 3,301 3,097 2,905 2,725
$(000)
PV (first 4 years) 12,028
PV (after 4 years) [4,443 x 1·03/(0·13 – 0·03)] x 1·13–4 28,067
Firm value 40,095Combined Co cash flow and value computation ($000)
Sales revenue growth rate = 5·8%, operating profit margin = 30% of sales revenue
Year 1 2 3 4
Sales revenue 51,952 54,965 58,153 61,526
Operating profit 15,586 16,490 17,446 18,458
Less tax (28%) (4,364) (4,617) (4,885) (5,168)
Less additional investment (18c/$1 of sales revenue increase)
(513) (542) (574) (607)
Free cash flows 10,709 11,331 11,987 12,683
PV (9%) 9,825 9,537 9,256 8,985
$(000)
PV (first 4 years) 37,603
PV (after 4 years) [12,683 x 1·029/(0·09 – 0·029)] x 1·09–4 151,566
Firm value 189,169Fodders growth rate in the past was: third root (16,146/13,550) – 1 = 0.06. The question says that after 4 years the growth will be half. 1/2 x 0.06 = 0.03.
For the combined company, the question says the growth rate will be 5.8% for the first 4 years and then will be half. 1/2 x 5.8% = 2.9% (or 0.029)
Hi Sir,
Why was tax allowable depreciation not added back in the free cash flow to firm calculation of Fodder Co?
Because the question says that “it can be assumed that its tax allowable depreciation is equivalent to the amount of investment needed to maintain current operational levels”.
This is something the current examiner always does and I do explain the implication in my free lectures.
Hi John,
This may be a silly question so apologies but why when calculating the PV of the combined company is the revenue difference between Year 4 and Year 1 used rather than the Year 4 figure itself (i.e $12,683 rather than $61,526)?
Thanks in advance.
Sorry John ignore me, i think it’s because it’s the incremental figure that needs to be used?
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