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co Politécnico Grancolombiano Bogotá, Colombia Joseph Tham Fulbright Economics Teaching Program Ho Chi Minh City Vietnam ThamJx@yahoo.com jtham@fetp.vnn.vn

Ignacio Vélez-Pareja is the Director of the Department of International Relations and Finance professor at Politecnico GranColombiano, Bogota, Colombia. Joseph Tham is a Project Associate at the Center for Business and Government, J.F.K School of Government. Currently, he is teaching at the Fulbright Economics Teaching Program (FETP) in Ho Chi Minh City, Vietnam. Constructive feedback and critical comments are welcome. The authors may be contacted at: ivelez@poligran.edu.co, ThamJx@yahoo.com. Ignacio Vélez-Pareja will be the presenter at the conference of the European Financial Management Association, June 27-30, 2001 in Lugano, Switzerland. Contact Information Politécnico Grancolombiano Calle 57 N 3-00 E Bogota, Colombia Phone #: (571) 3468800 Fax #: (571) 3469258

**Firm Valuation: Free Cash Flow or Cash Flow to Equity?
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Ignacio Vélez-Pareja ivelez@poligran.edu.co Joseph Tham ThamJx@yahoo.com jtham@fetp.vnn.vn

Abstract In a M & M world, the equity value is the present value of the Free Cash Flow FCF at the Weighted Average Cost of Capital WACC minus debt and it should be identical to the present value of the CFE (cash flow to equity) discounted at the cost of equity capital, e. In this paper the relationship between firm value calculated through the FCF and the CFE is examined. Several approaches to the firm value calculations are presented. We present a complex model where we compare the results obtained with the traditional M&M WACC found in the literature with the WACC approach presented by Harris and Pringle 1985. They make two assumpt ions that differ from the traditional M & M WACC. First, they assume that the discount rate for the tax shield is ρ, the return to unlevered equity. Second, based on the first assumption, the expression for e, the return to levered equity does not include the factor (1-T). Unlike the traditional WACC, the new WACC gives consistent results. However, the new WACC does not work if there are losses carried forward and/or the taxes are paid the following year. To solve these two practical issues, we present a ne w adjusted WACC. We call this adjusted WACC, TV WACC. In addition to the above-mentioned assumptions, this WACC is defined as a function of the real tax savings TS, earned. When this new approach is used, total consistency is found. In particular, with thi s new approach losses carried forward LCF and taxes paid at a different date as accrued, are taken into account and we obtain consistent values. Keywords Firm valuation, NPV, Free Cash Flow, FCF, Cash Flow to Equity, CFE, Cash Flow to Debt, CFD, Discounted Cash Flow, DFC. JEL Classification: D92, E22, G12, G31, M40, M41, M46

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are taken into account and we obtain consistent values. the new WACC gives consistent results. Value will never be found in accounting statements. Not even a dollar was earned and they sold the stocks for skyrocketed prices. We present a complex model where we compare the results obtained with the traditional M&M WACC found in the literature with the WACC approach presented by Harris and Pringle 1985. In particular. earned. Anyone could buy it. Several approaches to the firm value calculations are presented. When valuing a firm the idea is to measure that value. we present a new adjusted WACC. if she pays the price listed on the price tag. if somebody asks the owner of that project not to develop it. it has the capacity to create wealth and value. We call this adjusted WACC. What were they buying? Just value expectations. the return to unlevered equity. Just remember the boom of the dot com firms. they assume that the discount rate for the tax shield is ρ. They make two assumptions that differ from the traditional M & M WACC. To understand these ideas assume that there is a box with a machine inside. with this new approach losses carried forward LCF and taxes paid at a different date as accrued. the equity value is the present value of the Free Cash Flow FCF at the Weighted Average Cost of Capital WACC minus debt and it should be identical to the present value of the CFE (cash flow to equity) discounted at the cost of equity capital. she will ask for a premium in order not to start the project. First. The problems arise because what is sold is the value that can be created in the future. TV W ACC. the new WACC does not work if there are losses carried forward and/or the taxes are paid the following year. this WACC is defined as a function of the real tax savings TS. the return to levered equity does not include the factor (1-T). And where are these expectations? They are in the future cash flows. And this value is based on expectations of what the machine and the team could do in terms of wealth creation. In this paper the relationship between firm value calculated through the FCF and the CFE is examined. However. Where value lies? Some people think that the value of a firm is found in the financial statements. However. To solve these two practical issues. In fact. total consistency is found. e. a plan and a team led by an outstanding manager. 2 . Value arises from expectations. Unlike the traditional WACC.Introduction In a M & M world. When this new approach is used. the expression for e. Second. In addition to the above -mentioned assumptions. if that machine is accompanied by a strategy. greater that its price. based on the first assumption.

the discount rate for the tax shield is ρ. Unfortunately. This HP WACC differs from the MM WACC in two significant ways.Discounting the free cash flow FCF. Second. If there are LCF neither of the two expressions for WACC works. based on the first assumption. We assume that there are no losses and there are no losses carried forward (LCF) and taxes are paid the same year as accr ued. at the cost of equity. This WACC assumes that there are no losses and there are no losses carried forward (LCF) and taxes are paid the same year as accrued. In a M & M world. The problem lies in what is the correct discount rate to be used to discount the cash flows. In the traditional presentation. Some background on WACC In the literature we find the traditional presentation for WACC for discounting the FCF excluding tax savings from interest payments. We will call this the MM WACC. e is calculated as e = ρ + (1-T) (ρ – d)D%/E% (2) And the discount rate for the tax shield is d. This is. However. this traditional formulation does not work in the finite period cash flows. This paper studies this problem. We will show how using different approaches we arrive at different figures and we will show approaches that produce consistent results and those that do not. d is the cost of debt before taxes. We will examine the WACC proposed by Harris and Pringle (1985) and we call it the HP WACC. measures this future value. these two values must be equal. for the firm at the Weighted Average Cost of Capital and subtracting the debt or discounting the cash flow to equity holders CFE. It is expresse d as WACC = eE% + d(1-T)D% (1) Where e is the cost of equity. Then the correct WACC proposed by Tham & Velez (TV) is TV WACC = ρ – TS/(Total levered value) (4) 3 . e = ρ + (ρ – d)D%/E% (3) In practice we encounter losses carried forward (LCF). the expression for e does not include (1T). D% is the proportion of debt in total value and T is tax rate. E% is the proportion of equity in the total value. current practice find that this does not happens. These two values are not equal. First.

WACC = eE% + dD% . As it is invested in the firm. accounts receivable and payable policies. volume increases.TdD/(Total levered value) WACC = eE% + dD% . In line 4. prices and the rest. In the Cash Budget you will find that when the balance is in red. And this means that losses carried forward are included in the analysis. The complex model has several modules (See Annex).This last version of WACC assumes ρ as the discount rate for the Tax savings.TdD% WACC = eE% + dD% . the TS refers to the difference in the tax shield between the levered cash flows and the unlevered cash flows.TS/(Total levered value) (5) (6) (7) (8) This presentation is the most general way to express WACC. equity investments.TS/(Total levered value) WACC = ρ . We recognize that many other WACC are found in the literature. This information is used to calculate firm value and NPV in order to compare with market values. risk premium and debt ratio (accounting debt ratio)) for each year. In this paper we will show a comparison between the results obtained with the thre e versions for WACC1. With these inputs we calculate interest rates (from real rates. It can be seen as a different presentation of the typical WACC formula. inflation. prices increases and an elasticity function among others. There is not what some authors call “plugs” (an account where any difference between total assets and liabilities plus equity are included in order the Balance Sheet checks). it is expected to earn at least the WACC. P&L statements and Cash Budget or Working Cash Statement. In reality. These financial statements are all linked. 1 4 . automatically it determines how much to borrow We are restricting our comparison to the traditional MM WACC. prices. dividend and inventory “policies”. a cash cushion 2. the financial statements: Balance Sheet. From tables A12 to A16. See Taggart 1991 and Fernandez. In tables A1 to A7 are the inputs. Tables A8 to A11 present the forecasts of every variable including units sold. 2000 2 It is assumed that this amount of cash is deposited in a check account that is a nonbearing interest account. A Complex Model All these approaches work with a complex model. The inputs include initial costs. the “plug” is a decision: either to borrow money or to invest it (or leave it in the bank). It has the feature that considers tax savings when they are in fact earned.

In the complex model. Table 17 shows the expected WACC and growth beyond year 4. We present the value calculations for the three WACC approaches presented above. Tables A18 and A19 present the cash flow construction. To reinvest cash surpluses. dividends and tax savings. the analysis with WACC is inconsistent. In the cash budget the dividends paid are included. When tax savings are not earned (for instance. when there are losses) and losses carried forward. unless you use d(1-T) as the cost of debt after taxes. etc. These calculations are done fixing ρ for year 0. 3. A very important feature is the losses carried forward LCF. The cost of debt after taxes is calculated as the IRR for the CFD. the calculations of firm value and the different WACC’s are done when there are losses and LCF and when there are no losses. The possibility to consider inventory. These options are handled with a dummy variable. we calculate in the last part. To make inflation adjustments 2. PV(FCF) = PV(CFE) + PV(CFD) does not hold. In all cases it is assumed that taxes are paid at the same year as accrued. These inconsistencies are solved using the Adjusted WACC or TV WACC = ρ – TSt /(Total value at t-1). the WACC and firm value. equity from stockholders. All this means that it is not necessary to consider changes in working capital as with other methods.taking into account the cash cushion. It is calculated just as it is expected it will be in the Cash Budget. accounts receivable and payable policies. payout ratios. It doesn't matches if the cost of debt after taxes is calculated from CFD after taxes or if taxes are paid next year. When Adjusted WACC is used. As can be observed. the FCF is constructed from the Cash Budget balance and deduct all the items related with the financing: loans received and paid. consistency is obtained. This is quite important because this means that tax savings are earned when taxes are paid. In this model there exists some options: 1. Tables A20 to A33. With this information. Another features of the model are the presence of an elasticity factor that relates price increase and demand. is included. CFD and the CFE. 5 . cash cushion. To pay taxes the same year as accrued or not. The FCF. Not all the options are used in the example presented in the Annex. interest paid.

The results for the first case are summarized in Table 1 Panels A and B. with the HP WACC. with the HP WACC.9. with the traditional MM WACC. When calculating the Adjusted Present Value APV.9.176. When calculating the Adjusted Present Value APV.9.275. the present value is $48.505. where we assume that there are no losses and taxes are paid the same year. the losses are carried forward and taxes are paid the same year. However. the present value is $48. there is a difference of 1.996.3.4. with the traditional MM WACC. which is higher than the previous value by 2. the present value is $47. which is higher than the previous value by 115. Another reason is the difference in tax savings due to the LCF. the present value is $32.5. The differences are the same when calculated as Total value less debt. the present value is the same.3. 6 . there differences.439.225.3. for the same reason.2. when the market equity value is calculated from the CFE at e.316. when the market equity value is calculated from the CFE at e. With the traditional MM WACC.1. The reason the present value with the MM WACC is higher is because the discount rate for the tax shield is d lower than ρ. The reason the present value with the MM WACC is higher is because the discount rate for the tax shield is d. There are also differences when calculating the market equity value. The present value of the FCF at the TV WACC (total market value) is $47. the present value is $33. for the same reason.250.291. The reasons for this difference are the lower value for e (due to the (1-T) factor) and the difference in tax savings due to the LCF. The reason the present value with the HP WACC is higher is because the difference in tax savings due to the LCF. which is higher than the previous value by 1. This means a lower WACC. However. where we assume that there are losses. There are also differences when calculating the market equity value. The present value of the FCF at the TV WACC (total market value) is $47. When calc ulating the Adjusted Present Value APV. there is a difference of 253.4. The present value of the FCF at the TV WACC (total market value) is $47. lower than ρ.3.176. there is no difference. there is a difference of 376.9. The results for the second case are summarized in Table 2 Panels A and B.1. which is higher than the previous value by 933.066. This means a lower WACC. with the HP WACC.8. The present value of the FCF at the TV WACC (total market value) is $47.312. When calculating the Adjusted Present Value APV. which is higher than the previous value by 1. The present value of CFE at e under TV WACC assumptions is 31.7. The reason the present value with the HP WACC is higher is because the difference in tax savings due to the LCF.765.505. The differences are the same when calculated as Total value less debt.8.4. for the same reasons.

395.9. the present value is the same. the present val ue is $32. which is higher than the previous value by 933.8.329. with the HP WACC.there differences. 7 . With the traditional MM WACC. The present value of CFE at e under TV WACC assumptions is 31.9. The reasons for this difference are the lower value for e (due to the (1-T) factor) and the difference in tax savings due to the LCF.

4 115.176.312.5 1. if precision is desired.312.3 31.9 1.2% 32.316.0% 33. Losses. However. Column (6) shows the values when calculated with the MM WACC. losses carried forward and taxes paid the same year Total market value.765.4 31.5 32.4 253. Value calculation (1) With TV With HP WACC (TV WACC WACC = e=ρ+(ρ-d)D/E ρ – TS/(Total (3) value) e=ρ+(ρ-d)D/E (2) 47.115. losses carried forward and taxes paid the same year Total market value.3 Difference with TV WACC (4) % over TV With MM WACC WACC e= (5) ρ+(1-T)(ρ-d)D/E (6) Difference with TV WACC (7) % over TV WACC (8) Total value PV(FCF @ WACC) Total value PV(CCF=FCF + TS @ ρ) Total value = PV(FCF at ρ) + PV(TS at d) 47.2 32.8% 7.066.debt Equity value = PV(CFE @ e) 31.debt Equity value = PV(FCF at ρ) + PV(TS at d) .066.066.379.429.996.5 48. From columns (4) and (5) it can be seen that in this case TV WACC and HP WACC differ.275.5% Table 1 Panel B.7 Column (1) of Table 1 (panels A and B) shows the name of the procedure to calculate Total or Equity value. TS.291.4% 4.3 31.1% 4.225.489.4 253. In table 2 the traditional WACC (MM WACC) also shows inconsistencies among the different values and between those values and the TV WACC. Notice the internal consistency of TV WACC.5 1.2 115.4% 0.250.1 1.3 3. Equity market value Value calculation (1) With TV With HP WACC (TV WACC WACC = ρ – e=ρ+(ρ-d)D/E TS/(Total (3) value) e=ρ+(ρ-d)D/E (2) 31. this is WACC = eE% + d(1-T)D% where e=ρ+(1-T)(ρ-d)D/E Columns (7) and (8) show the absolute and relative difference with the TV WACC.181.2% 0. 8 .2 2.debt Equity value = Total value (from CCF at ρ) . Both of them consider e=ρ+(ρ-d)D/E and assume ρ as the correct discount rate for the tax savings. TV WACC should be used. The very small differences between TV WACC and HP WACC might show that for practical purposes HP WACC is a good approximation. Losses.In summary Table 1 Panel A.2% 2.3 Difference with TV WACC (4) % over TV With MM WACC WACC e= (5) ρ+(1-T)(ρ-d)D/E (6) Difference with TV WACC (7) % over TV WACC (8) Equity value = Total value (from FCF at WACC) .996.8% 48. Columns (2) and (3) show the different values when the Adjusted or TV WACC = ρ – TS/(Total value) and HP WACC = eE% + d(1-T)D%.3 47. Columns (4) and (5) show the absolute and relative difference with the TV WACC.4 47.1 1.2 2.9 0.1 0.319.176.

taxes paid the same year and it is shown that there is no difference.9 (0. Columns (2) and (3) show the different values when the Adjusted or TV WACC = = ρ – TS/(Total value) and TV WACC = eE% + d(1-T)D% are used.Table 2 Panel A No losses.9 31.0) 0.0% 47. Notice the internal consistency of TV WACC and HP WACC.395. No losses.395.84 933.8 47. 9 . Panels A and B.505.8 0.8% Difference with TV WACC (7) 933.0) 0.0% 376.0) 0. Both of them consider e=ρ+(ρ-d)D/E and assume ρ as the correct discount rate for the tax savings.329.9 (0.505.7 376.505.0% 32.439.395. taxes paid the same year With TV WACC With HP Difference % over TV With MM WACC (TV WACC = ρ – WACC with TV WACC e= (5) ρ+(1-T)(ρ-d)D/E TS/(Total value) e=ρ+(ρ-d)D/E WACC (4) e=ρ+(ρ-d)D/E (3) (6) (2) Equity value = Total value (from FCF at WACC) 31.395.9 % over TV WACC (8) 2.0% Total value = PV(FCF at WACC) Total value = PV(CCF = FCF + TS at ρ) Total value = PV(FCF at ρ) + PV(TS at d) Table 2 Panel B.9 % over TV WACC (8) 3.7 32.9 31.8 Difference with TV WACC (7) 933. No losses.0% Value calculation (1) Equity value = PV(FCF at ρ) +PV(TS at d) . Column (6) shows the values when calculated with the MM WACC.9 0.2% 3.0 0. taxes paid the same year Value calculation (1) With TV WACC With HP Difference % over TV With MM WACC (TV WACC = ρ – WACC with TV WACC e= TS/(Total value) e=ρ+(ρ-d)D/E WACC (5) ρ+(1-T)(ρ-d)D/E (4) e=ρ+(ρ-d)D/E (3) (6) (2) 47.debt Equity value = PV(CFE at e) 31. shows the name of the procedure to calculate Total or Equity value.9 (0.0% 48. TS.9 (0.772.9 47.debt 31.9 31.9 1.0) 0.395.0% 31. this is WACC = eE% + d(1-T)D% where e=ρ+(1-T)(ρ-d)D/E Columns (7) and (8) show the absolute and relative difference with the TV WACC.882. In Table 1. In table 2 the traditional WACC (MM WACC) shows inconsistencies among the different values and between those values and the TV WACC.395.505.329.0% Column (1) of Table 2.9 47. Columns (4) and (5) show the absolute and relative difference with the TV WACC.8 debt Equity value = Total value (from CCF at ρ) .

110. Journal of Financial 10 .721. R.8 39. The last one.2 23. It can be shown that when taxes are paid the following year after accrual.378.395.4 54.2 38.110.1 55.176. HARRIS .9 1.8 67. Market and book values ratios Year 1 Year 2 Year 3 Year 4 Book value for equity Market value for equity Market equity value/equity book val ue Book value for total assets Market total value Market total value/Book value for total assets 24.9 71.0 47.7 Year 4 30.193.5 2.0 31.2 24.4 1.693.Table 3 No losses.5 54.961.733.8 Table 4.7 42.7 43. Frequently.3 1.125.8 39.104. 1985. Market and book values ratios Year 1 Year 2 Year 3 Book value for equity Market value for equity Market equity value/equity book value Book value for total assets Market total value Market total value/Book value for total assets 24.8 1.220.8 67.S. the tables give an idea on how much difference is present when the book values are used. These differences are explained because the financial statements do not consider any terminal value.0 47.809. Bibliographic References FERNÁNDEZ .3 1.1 37.3 40.2 63.0 1.0 31.2 38.8 62. “Risk-Adjusted Discount Rates – Extensions from the Average-Risk Case ".4 26. Working Paper. Conclusions We have shown three approaches to calculate total and equity value with different expressions for WACC. the only one that gives consistent results is TV WACC.1 2.953. losses carried forward and taxes paid the same year.3 40.000.1 2. 2000.654.8 Tables 3 and 4 show the differences in market values when compared with book values.1 37.030.719.J.000. the TV WACC. Although not a formal proof. AND J. Losses.022.3 1.534. produces consistent results either with no losses or losses and losses carried forward. We consider that this is the correct method.773. Equivalence of the Different Cash Flow Valuation Methods. the HP WACC and the TV WACC.505.651. They are the MM WACC (the traditional WACC).3 1. terminal value accounts for more that 50% of the total value of the firm. The first one produces inconsistent results. The second one is consistent as long as there are no losses and/or losses carried forward.149. The equity market values are taken from the calculations made with the TV WACC approach. PABLO.9 1.7 30.7 71.6 55.3 2. taxes paid the same year.204. PRINGLE. Social Science Research Network.763.1 1.6 1.066.708.221.050.4 26.9 1.

JR. pp8-20 11 . Financial Management.Research. Fall. Consistent Valuation and Cost of Capital Expressions with Corporate Taxes and Personal Taxes. ROBERT A.. Autumn. pp 237-244. TAGGART . 1991.

00% Year 4 6.55% 28.0% 40.00% 30.00% 9.59% 28.59% 30.00% 10.62% 22.64% 12.00% This information can be estimated based on the behavior of bonds or simply setting the cost of debt from a contract between the firm and the debt holder.55% 22.00% 4.62% 22.01% 1.0% Year 4 40.00% 10.0% Year 3 40.00% Year 2 Year 3 Year 4 The purchase price is a function of Q.00% 12.90% 13.00% 6.62% 6. Fisher Theorem is used to compose the three components.00% 10.0% 9.59% 30.59% 30. 12 .00% 11.00% 5.00% 6. Table A2 Market variables Quantity to sell at year t at price given at year 0 Increase in volume 7. the estimated quantity the market will buy. Table A3 Risk free discount rate and risk premium estimates Year 0 Year 1 Year 2 Year 3 Real risk free discount rate Rate of interest for debt Risk premium for debt Effective rate before taxes Annual nominal rate compounded twice a year Effective rate after taxes 10.00% 7.95 0.247 0.55% 28.62% 22.00% 11.55% 28. Table A4 Price and increase in price Year 0 Year 1 Purchase price Real price increase Annual increase in purchase price $2.00% 10.00% This information can be obtained from macroeconomic forecasts made by the government or associations or universities.82% 1.00% Year 0 Year 1 Year 2 Year 3 Year 4 The quantity and increase in the market might be obtained by a marketing research.10% 0.ANNEX FINANCIAL ASSESMENT FOR THE CREATION OF A FIRM LOSSES AND LOSSES CARRIED FORWARD (LCF) Table A1 External or macroeconomic variables Year 0 Year 1 Year 2 Tax rate Inflation rate 40.

32% 3. Price increases might be estimated based on historical data of similar firms.76% 12. an elasticity function calculated for the domestic water supply was used.00 $0.9974 The elasticity function has to be found for the specific product or service we are dealing with.60% Year 3 Year 4 0.00% $0.32% Year 4 $0.9971 0.65% 3.01% Year 2 $0.00 1.10% 10.366*((1+increase in selling price)/(1+inflation)-1)) $5.00 1.12% $0.00 1.900% 13.55% 3.00 0.000% 13.10% 0. Effect of price change upon demand.00 1.00 $0.11% 11.20% 13.00 0.67% 10.90% 9.00 Year 1 $0.80% 0. Table A6 Costs Year 0 Monthly auditing fees Real price increase Increase in monthly auditing fees Monthly overhead Real price increase Increase in overhead Monthly payroll Administrative payroll Monthly payroll of selling force Real price increase Increase in payroll Sales commissions Fringe benefits and taxes over payroll 56.44% $0.00 1.93% $160.22% Year 3 $0.00 $0.20% 11.30% 12.20% These are stated on a monthly base.9996 0. It is a function of selling price increase.9978 0.10% 12.98% $0.20% 11.00 1.00 1.60 0.00 $37.60% 9.30% 11.00% $0.88% 0.00 1.00 $0.34% 3.00 $40.Table A5 Internal variables (endogenous) with some degree of negotiability Year 0 Year 1 Year 2 Selling price Real price increase Increase in selling price Elasticity factor.00% $0.00 1.43% $0.40% 12.00 0.00 $0.00 $0. Selling price is the result of a market survey and/or the cost structure of the good or service.00 $0.00 $145.70% 9. (1-. 13 . or simply a subjective forecast. In the example.00 $0.00% $0.

000.424.243.00% 110 120 131 160 160 Many variables are just policies or target the firm will pursue.399.53 4.00% 30.74 644.00% 10.00% 5.00 This depreciation is based on the lineal method stated above.00% 90.00 40.00% 90.11 Year 4 8.000.50 8.774.00% 90.00% 95.03 These prices are based on the initial selling and purchasing price and the price increase stated above. Table A9 Depreciation Year 1 Year 2 Annual depreciation Cumulative depreciation 8.28 3.00 Year 3 8.36 Units to be sold are based on the initial market survey.000.66 7. Table A8 Forecasts based on Tables A1 to A7 Year 1 Year 2 Units sold (increase plus elasticity effect) S Final inventory in units FI Initial inventory in units II Purchases in units P = S + FI . 14 .17 699.00% 3.33% 8.847.00% 95.00% 30.33% 8.733.00 3.00 32.00 Year 4 8.33% 95.77 3.000.00 16.000.01 3.00% 30.95 644.13 8.II 7.33% 24.00 24.00% 30.000.79 Year 3 8.00% 5. the increase in volume and the elasticity factor for the product or service.127. The nominal selling price increase defines the elasticity factor.00 7.00% 10.00% 3.87 674.00% 8.00% 10.00% 95. Table A10 Selling and purchasing prices Year 1 Year 2 Year 3 Year 4 7.90 603.000.74 8.56 7.00 8.00% 10.00 8.50 603.096.000.00% 5.81 Selling price Buying price 6.000.56 7.Table A7 Targets and/or operating policies Year 0 Advertising and promotions (% on sales) Equity contribution Fixed assets Depreciation (lineal for 5 years) Final inventory as percent of sales (units) Inventories valued at FIFO Percentage of sales receivedin the same year Percentage of sales receivedin the next year Percentage of payments made the same year as accrued (overhead and suppliers) Percentage of payments made the next year as accrued (overhead and suppliers) Percentage of net profits (dividends) paid to stockholders the year after obtained the net profits Minimum cash balance desired after financing deficits 8.93 674.00% 5.000.00% 90.00% Year 1 Year 2 Year 3 Year 4 3.66 0.

719.364.18 8.11 2.14 502.00 16.000.206.00 0.766.100.00 32.00 12.398.44 1.21 3.813.50 7.654.80 26. cash is the same value found in the Cash Budget as cumulative cash balance.000.457.866.985.160.34 1.00 11.000.000.00 Year 2 Year 3 Year 4 27.21 41.364.000.16 747.000.030.706.312.574.456.00 (46.76 3.861.814.888.56 564.000.39 245.726.966.110.00 32.76 38.00 2.20 181.273.48 2.076.00 110.178.Annual expenses Table A11 Administrative and selling expenses Year 1 Year 2 2.00 40.393.823.06 2.37 159.00 24.70 0.000.68 40.000.626.00 4.38 0.43 16.00 5.574.030.055.50 15. Net income 15 .28 2.890.75 2.26 196.91 249.45 37.61 186.69 40.45 2. Table A12 Balance sheet Year 0 Year 1 Assets Cash Accounts receivable Inventory Fixed assets Cumulative depreciation Net fixed assets Total Liabilities and equity Accounts payable (suppliers) Accounts payable (overhead) Fringe benefits accrued Interest charges accrued Accrued taxes Long term debt Total liabilities Equity Cumulative retained earnings Net income for the year Total net equity Total 24.00 (46.953.654.583.15 629.12 24.22 214.69 41.00 39.25 1.00 16.25 2.67 30.433. For instance.711.176.541.00 16.149.91 24.110.61 Year 3 2.26 692.000.31 24.650.000.70 490.34) 2.00 8.000.97 2.082.04 1.00 40.12 612.278.719.027.110.000.37 2.30 2.267.16 2.534.34) 23.95 241.67% payroll and commissions) Auditing fees Overhead Advertising and promotions These costs are based on the monthly based costs above.000.888.02 2.00 8.293.67 1.719.000.35 544.0 2.03 37.147.00 2.66 390.66 39.449.33 All the financial statements are linked.534.78 24.43 37.00 1.65 1.00 8.00 4.626.00 24.41 204.000.64 441.000.68 227.33 3.05 1.95 Administrative payroll Administrative fringe benefits on payroll Sales force payroll Sales commissions Fringe benefits (annual premium 1/12 of payroll) Other fringe benefits (46.96 1.559.11 5.00 16.88 40.00 2. 63 340.149.22 Year 4 2.35 1.000.00 40.04 40.39 0.000.000.110.61 0.81 270.78 38.00 8.94 220. 58 2.166.62 3.989. In this table they are annualized.00 24.22 681.221.20 40.

39 502.574.40 19.00 1.66 4.595.265. Table A13 Profit and losses statement Year 1 Year 2 Sales Cost of goods sold Initial inventory Purchases Final inventory Gross profit Selling and administrative expenses Payroll expenses Annual premium Auditing fees Selling commissions Overhead Depreciation Advertising Earnings before interest and taxes Other expenses (interest expenses) Earnings before taxes Taxes Net profit 45.00 1.738.44 8.217.00 (46.34 8.24 6.00 2.57 1.11 2.97 2. etc.723.50 441. and so on.479.890.37 4.20 22.00 (46.480.38 629.755.574.748.45 2.940.00 8. There is no plug.11 3. Sales are simply quantity to be sold times the rice. In this case.22 10.300.25 1.11 2.572.68 26.37 27.000.38 5.000.68 31.456.00 24.75 1.95 2. Items such as taxes will appear in the Balance Sheet in case taxes are paid the following year.15 2.32 390.823.600.178.631.286.16 21.37 1.97 8.598.00 1.70 564.22 2.40 340.35 8.340.13 4. 16 .000.04 32.888.31 2.03 62.682.34) 0.149.63 5.138.38 1.890.69 30.79 18.97 1.30 1.16 22.00 13.for the year is the same found in the P&L statement.364.89 2.553.61 2.61 7.626.52 2.966.38 0.05 5. they appear as a cash outflow at the Cash Budget.243.88 37.149.65 490.04 33.267.220.988.664.61 692.000.198.62 22.452.206.669.150.20 27.77 3.954.706.450.80 Year 3 Year 4 71.293.00 3.95 15.888.393.44 5.926.796.76 1.626.34) 54.982.65 8.67 The figures for the P&L statements are based on the forecasts above.93 33.003.293.988.705.788.364.931.

966.00 1.02 59.664.480.00 0.00 36.00 680.96 51.504.988.670.20 2.00 43.456.32 27.421.69 43.69 71.22 2.793.702.02 50.595.43 43.669.34 2.15 Total payments to suppliers Payroll and fringe benefits Annual premium year Auditing fees Commissions on sales Payment of overhead year 1 Payment of overhead year 2 Payment of overhead year 3 Payment of overhead year 4 Advertising Purchase of fixed assets Interest expenses Dividend payments Taxes Total cash outflows 40.66 2.00 22.972.95 220.44 5.000.205.589.16 54.31 62.57 Payments for purchases year 2 27.33 22.000.00 1.888.457.150.903.03 68.64 2.783.00 3.572.37 62.95 0.27 1.97 3.364.553.364.769.62 56.32 502.509.711.205.115.220.97 1.31 62.79 245.504.70 629.44 2.940.50 6.452.081.598. Table A15 Cash budget: Cash outflows Cash outflows Suppliers Payments for purchases year 1 24.63 17 .39 30.149.26 24.72 24.147.20 53.11 Year 0 Year 1 Year 2 Year 3 Year 4 1.450.340.00 0.32 2.000.30 441.65 3.902.39 564.35 40.003.313.40 5.34 1.Cash inflows Table A14 Cash budget: Cash inflows Year 0 Year 1 45.100.00 1.783.706.888.22 2.50 3.94 27.206.72 In this table all the cash inflows are registered.98 1.60 0.38 692. It does not include loans income.115. It is a financing decision that will be made with the cash balance below.205.65 390.71 196.985.000.00 0.63 1.89 Payments for purchases year 4 33.45 Payments for purchases year 3 31.75 5.67 71.228.705.61 0.626.00 Year 2 Year 3 Year 4 Cash collection of sales year 1 Cash collection of sales year 2 Cash collection of sales year 3 Cash collection of sales year 4 Total income accounts receivable Equity in cash Total cash inflows 43.600.65 2.44 33.479.273.72 4.436.20 53.228.37 1.210.359.76 30.982.25 340.689.35 2.300.67 71.00 2.766.149.37 1. It takes into account the accounts receivables policy stated above.61 1.50 2.626.00 4.93 24.

62 27.00 4.421.06 16.811.59 0.312.00 4.This table shows all the cash outflows.78 9.50 0. These are.43 43. how much should beborrowed and how much can be paid with the available cash.29 12.05 14.00% This table shows the growth and discount rate for determining the terminal value .00 Year 2 Year 3 Year 4 24.1 6. 18 .702.00) (16.110.783.526.813.00 0.756.28 5.50 0.000. Table A16 Financing decision Year 0 Year 1 Total cash inflows Total cash outflows Net cash gain (loss) Cash balance at end of year Bank loans Repayment of loans (principal) Investment of surplus Net cash gain (loss) after financing Cash balance at end of year after financing and reinvestment 110.00 4. It does not include loans payment. Table 17 Discount and growth rate beyond year 4 Discount rate for cash flows beyond year 4 Growth for year 5 Growth for year 6 and following years 23.21 This table shows the information from the Cash Budget in order to make the financing decisions.00 4.027.71 0.228.63 6.10% 0.191.00 0.783.498.027.31 62.11% 10.78 12. These are included below.027.972.677.00 40.00) 16.00 0.866.205.00 36.163.000.000.28 2.504.67 71.00 2.650.313.00 110.56 20.02 50.50 8.841.55 10.339.000.79 8.72 (16.12 31.783.20 53.027.50 0.62 56.893.00 43.

55% 11.00 4.60 0.783.498.89 Year 4 91.05 The FCF is calculated from the Cash Budget.28 Year 2 5.251.5 6.251.55 4.682.327.964.027.00 4.627.251.00 0.450.78 8.5 7. the cost before and after taxes calculated as the IRR of the CFD before and after taxes.50 2.756.00 4.383.769. Table A19 Cash Flow to Equity CFE and Cash Flow to Debt Cash flow for stockholder (dividends plus any cash ) Financing cash flow (after tax) CFD Cost of debt as IRR of after tax CFD Financing cash flow (before tax) Cost of debt as IRR of before tax CFD Free cash flow (FCF) Financing cash flow (CFD) Stockholder's cash flow (CFE) Check: CFD + CFE =FCF Year 1 2.00 11.627.783.28 11.69 18.50 96. We do not use the approach to calculate FCF from EBIT or net profit because this method increases the probability of errors.00 Year 3 Year 4 Year 5 8.78 11.59 0. In particular.28 0. starting from EBIT might introduce errors in the tax paid and the tax savings earned.13% 8.097.097.756.464.55 10.00 0.29 5.881.627.027.13 (Plus) 79.78 6. the CFE.78 11.39 96.50 3.477.756.407.29 14.36 11.027.55 96.00 0.05 8.383.39 This table shows the CFD.50 91.383.29 6.50 4.05 4.34 1.682.380.881.50 11.843. 19 .00 (920.843.79 Year 3 8.00 680.00 0.407.29 14.50 28. Cost of debt is assumed constant.177.5 17.600.717.00 Year 2 5.682.881.Table A18 Construction of Free Cash Flow (FCF) from the Net Cash Gain at the Cash Budget Year 1 Net cash gain (loss) after financing Bank loans Repayment of loans (principal) Interest expenses Tax shield for interest payments Dividends Equity in kind Equity in cash Cash flow without terminal value FCF n+1 = (FCFn (1+Growth rate for n+1) Terminal value Free cash flow after taxes (Plus) (Minus) (Plus) (Plus) (Minus) (Plus) (Minus) (Minus) 2.50 5.150.50 14.50 4.50 2.00) 0.39 5.00) 0.00 1.912.5 5.00 (1.553.383.163.00 0.39 16.300.89 14.79 0.00) (460.50 8.783.00 0.027.964.717.251.79 11.881.

477.00 1.50 460. except for the tax savings TS.142.027.763.34 54.29 62.61 In table the resulting WACC and market values are shown.00 4.027.763.383.380.50 7.00 40.15% 25.7135 11.00% 28.00% 28.13% 0.61 Year 4 97.50 6.55% 37.50 Year 4 40.55% 36.177.150.85 36.027.29 8.055.18% 35.15% 47.00 40.00 40. Table A20 Basic information for TV WACC calculations Year 0 Year 1 Year 2 Year 3 Tax rate Cost of debt before taxes Given nominal ρ year 1 and assuming constant risk Real ρ (deflated) Discount factor at ρ FCF Debt (balance) Initial Equity contribution (book value) Initial investment (fixed assets plus cash) Interest payments Debt payment Cash flow to debt before taxes Tax savings (TS = TdD) 16.110.176.383.78 54.733.220.00 4.881. It has to be remembered that there exists circularity and this is the result of iterations done by the spreadsheet.00% 28.627.The next tables show the calculation of market values and the three different approaches to calculate WACC.13% 0.65% 25.40% 25.00% 28.00 4.50 920.027.30 Year 3 Year 4 36.027.30 15.78 12.39 71.176. First.000.171.38% 62.327.251.00 2.00 4.55% 38.39 4. We do not calculate the TS straightforward with the formula TdD.733.220.00 24.600. we determine how much TS is earned according to the financial situation of the firm.50 5.TS/Total value at t-1 Market Total Value at t @ WACC 40.34 11.50 8.50 40. Table A21 TV WACC and market value calculations Year 0 Year 1 Year 2 WACC after taxes = ρ .110.2736 96. we present the TV WACC approach.300. With the TV WACC approach.5137 11.082.450. This is.50 0 3.3732 14.00 4.05 20 .50 1. TS are calculated in an explicit way.90% 25.13% 0.261.05 This information is common for the three methods.13% 0.85 13. Table A22 Capital Cash Flow and market value calculations at ρ Year 0 Year 1 Year 2 Year 3 Capital cash flow (CCF = FCF + TS) Total value 47.682.75% 71.55% 40.

Table A23 APV and market value calculations Year 0 Year 1 Year 2 Year 3 PV(FCF at ρ ) PV(TS at ρ ) Total 45.50 8.30 36.22 1.998.99% 8.29 8.027.176.25 70.327.000.00 4.55 67.177.00 2. Table A25 Basic information for HP WACC calculations Year 0 Year 1 Year 2 Year 3 Tax rate Cost of debt before taxes Given nominal ρ year 1 and assuming constant risk Real ρ (deflated) Discount factor at ρ FCF Debt (balance) Initial Equity contribution (book value) Initial investment (fixed assets plus cash) Interest payments Debt payment Cash flow to debt before taxes Tax savings (TS = TdD) 16.22 1.50 6.756.380.28 31.178.00 40.40% 25.651.13% 0.00% 28. TS are calculated in an explicit 21 .83% 5.13% 0.066.50 7.840.90% 25.7135 11.11 53.39 4.682.450.5137 11. Table 24 CFE.027.849. In this table the market value is calculated directly with the CCF and ρ.00 3.027.Capital cash flow is defined as CCF = FCF + TS.55% 40.00 1.178.193.00% 28.89 54.34 41.05 This information is common for the three methods.964.082.00% 28.50 5. With the TV WACC approach. In the following tables the HP WACC approach is presented.998.34 45.50 1.783.11 In table the resulting e and equity market values are shown.39 Year 4 337.477.50 Year 4 40.00 4.00 4.883.55% 37.881.110.87% 91.16% 2.027.027.110.35 38.73 1.627. It has to be remembered that there exists circularity and this is the result of iterations done by the spreadsheet.251. e and market value of equity calculation with CFE at e Year 0 Year 1 Year 2 Year 3 Year 4 e=ρ +(ρ -d)D/E CFE=FCF+TS-CFD PV(CFE at e) 46.78 12.12 61.651.50 1.15% 25.300.50 460.13% 0.00 40.00 4.00% 28.11 47.082.843.150.383.79 42.600.91 913.50 920.00 24.708.65% 25.50 40.13% 0.00 4.55% 38. except for the tax savings TS.00 40.55% 36.3732 14. are the same.055.36 Capital cash flow and APV with the TS discounted at ρ.2736 96.

Table A28 APV and market value calculations Year 0 PV(FCF at ρ ) PV(TS at ρ ) Total 45.67% 22.998.489. 22 .220.849.33% 36.60% 41.91 913.939.00% 33.22 2.22 2.36 337.08% 39.96% 36.1% 53.40% 22.22 Year 1 45.way.62% 7.489.14% 30.25 Capital cash flow and APV with the TS discounted at ρ. This is.082. It has to be remembered that there exists circularity and this is the result of iterations done by the spreadsheet.94 77. are the same.42% 38.93% 46.85 15.058.07% 12.99 48.763.61 Capital cash flow is defined as CCF = FCF + TS.490.62% 1.22 13.324.39 Year 4 70.62% 2.9% 71. In this case we calculate the TS straightforward with the formula TdD.88% 32.73 1. The HP WACC is calculated based on the contribution of each: the debt and the equity.92% 22.05 71.78% 36.07% 22.39 62.142.28% Year 1 Year 2 Year 3 Year 4 In table the resulting WACC and market values are shown.92% 5.998.223. Table A26 HP WACC and market value calculation at HP WACC Year 0 ρ known Year 0 Debt Weight for Debt D% After tax cost of debt Contribution of debt to WACC Equity Weight for Equity E% et =ρ t + (ρ t – d)Dt -1/Et -1 Contribution of equity to WACC WACC after taxes Market Value at t @ WACC 47.883.490. we determine how much TS is earned according to the financial situation of the firm.99 Year 2 53. Table A27 Capital Cash Flow and market value calculations at ρ Year 0 Year 1 Year 2 Year 3 Year 4 Capital Cash Flow (CCF = FCF + TS) Total value 13.651.291.12 Year 3 61.71% 22. In this table the market value is calculated directly with the CCF and ρ.47 65.733.62% 5.50% 37.30 97.87% 34.171.6% 62.45 94.78 48.11 87.29 54.261.1% 34.

00% 28.55% 37.027.00 1.00% 28. In this case we calculate the TS straightforward with the formula TdD.Table 29 CFE.2736 96.027.682.89 54.027.027. Table A30 Basic information for MM WACC calculations Year 0 Year 1 Year 2 Year 3 Tax rate Cost of debt before taxes Given nominal ρ year 1 and assuming constant risk Real ρ (deflated) Discount factor at ρ FCF Debt (balance) Initial Equity contribution (book value) Initial investment (fixed assets plus cash) Interest payments Debt payment Cash flow to debt before taxes Tax savings (TS = TdD) 16.55% 38.28 32.50 5.964.90% 25.00 40.082.783.5137 11.300.316.843.50 460.50 Year 4 40.78 12.36 Year 3 8.055.00% 28.00 4.63 Year 4 91.703.50 1. This is. Now.00 40.00 4.627.327.177.840.192.380.383. TS are calculated in an explicit way.7135 11.13% 0. except for the tax savings TS.39 4.00 3.13% 0.50 920.13% 0.43 Year 2 5.55 67.13% 0.110.50 1. and market value of equity calculation with CFE at e Year 0 CFE=FCF+TS-CFD PV(CFE at e) 32.600.55% 36.29 8. With the TV WACC approach.00 4.631.00 2.316. the MM WACC approach is presented.55 In table the resulting e and equity market values are shown.00% 28.55% 40.000.00 40.110. 23 .00 24.15% 25.150.450.79 42.50 7.65% 25.00 4.881.50 6.00 4.3732 14.50 40.40% 25.027.596. we determine how much TS is earned according to the financial situation of the firm.50 8.251.43 Year 1 4.05 This information is common for the three methods. It has to be remembered that there exists circularity and this is the result of iterations done by the spreadsheet.477.

It has to be remembered that there exists circularity and this is the result of iterations done by the spreadsheet.83% 40.59% 43.431.59 77.67% 31.62% 1.02% 12.604.06% 36. The FCF is discounted at ρ and the TS is discounted at d.66% 22.201.275.4% 71. The HP WACC is calculated based on the contribution of each: the debt and the equity.073.2 1.151.3 47.89 54.68% 34.964. It has to be remembered that there exists circularity and this is the result of iterations done by the spreadsheet.Table A31 MM WACC and market value calculations Year 0 ρ known Year 0 WACC calculations Debt Weight for Debt D% After tax cost of debt Contribution of debt to WACC Equity Weight for Equity E% et =ρ t + (1-T)(ρ t – d)Dt -1/Et -1 Contribution of equity to WACC WACC after taxes Market Value at t @ WACC 48.082.985.45% 33.91% 5.41% 22.501.55 67. Table A32 APV and market value calculations Year 0 PV(FCF at ρ ) PV(TS at d) Total 45.429.7% 62.34% 36.5 Year 3 61. Table 33 CFE.4 357.79 43.998.843.72 Year 2 5.9 715.56% 22.28 33.431.3 Year 2 53.2 1.60% 35.9% 33.7 Year 4 70.62% 2.7 1.66 Year 4 91.08 94.998.40 In table the resulting e and equity market values are shown.27 87.51% 36.596.28% Year 1 Year 2 Year 3 Year 4 In table the resulting WACC and market values are shown. 24 .8 In this case.13% 38.41 66. and market value of equity calculation with CFE at e Year 0 CFE=FCF+TS-CFD PV(CFE at e) Year 1 4.6% 54.62% 7.285.87% 22.17% 22.849.5 Year 1 45.04 Year 3 8.65% 36.62% 5.64% 29.225.783.883. the CCF does not have any meaning.

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