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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?
**

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

1

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

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 assume that there are no losses and there are no losses carried forward (LCF) and taxes are paid the same year as accr ued. If there are LCF neither of the two expressions for WACC works. Second. We will call this the MM WACC. this traditional formulation does not work in the finite period cash flows. based on the first assumption. However. It is expresse d as WACC = eE% + d(1-T)D% (1) Where e is the cost of equity. 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.Discounting the free cash flow FCF. the discount rate for the tax shield is ρ. 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. at the cost of equity. Unfortunately. 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. Then the correct WACC proposed by Tham & Velez (TV) is TV WACC = ρ – TS/(Total levered value) (4) 3 . D% is the proportion of debt in total value and T is tax rate. In a M & M world. measures this future value. d is the cost of debt before taxes. e is calculated as e = ρ + (1-T) (ρ – d)D%/E% (2) And the discount rate for the tax shield is d. First. This HP WACC differs from the MM WACC in two significant ways. These two values are not equal. This is. the expression for e does not include (1T). The problem lies in what is the correct discount rate to be used to discount the cash flows. We will examine the WACC proposed by Harris and Pringle (1985) and we call it the HP WACC. E% is the proportion of equity in the total value. current practice find that this does not happens. e = ρ + (ρ – d)D%/E% (3) In practice we encounter losses carried forward (LCF).

In tables A1 to A7 are the inputs.TdD/(Total levered value) WACC = eE% + dD% . In the Cash Budget you will find that when the balance is in red. WACC = eE% + dD% . From tables A12 to A16. 2000 2 It is assumed that this amount of cash is deposited in a check account that is a nonbearing interest account. 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. Tables A8 to A11 present the forecasts of every variable including units sold. it is expected to earn at least the WACC. the financial statements: Balance Sheet. dividend and inventory “policies”. a cash cushion 2. With these inputs we calculate interest rates (from real rates. See Taggart 1991 and Fernandez.TS/(Total levered value) WACC = ρ . inflation. In line 4. prices. As it is invested in the firm.This last version of WACC assumes ρ as the discount rate for the Tax savings. The complex model has several modules (See Annex). volume increases. In reality. prices increases and an elasticity function among others. A Complex Model All these approaches work with a complex model.TdD% WACC = eE% + dD% . equity investments. the TS refers to the difference in the tax shield between the levered cash flows and the unlevered cash flows. prices and the rest. It has the feature that considers tax savings when they are in fact earned.TS/(Total levered value) (5) (6) (7) (8) This presentation is the most general way to express WACC. These financial statements are all linked. accounts receivable and payable policies. 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). 1 4 . automatically it determines how much to borrow We are restricting our comparison to the traditional MM WACC. The inputs include initial costs. P&L statements and Cash Budget or Working Cash Statement. In this paper we will show a comparison between the results obtained with the thre e versions for WACC1. It can be seen as a different presentation of the typical WACC formula. And this means that losses carried forward are included in the analysis. the “plug” is a decision: either to borrow money or to invest it (or leave it in the bank).

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

9. 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. where we assume that there are losses.5.176. The differences are the same when calculated as Total value less debt. where we assume that there are no losses and taxes are paid the same year.176. The differences are the same when calculated as Total value less debt. the present value is $33. With the traditional MM WACC. there is a difference of 253. the present value is $32.2.291. 6 . there is a difference of 1.4.3.9. for the same reason. which is higher than the previous value by 115. The present value of the FCF at the TV WACC (total market value) is $47. the present value is $48. lower than ρ. When calculating the Adjusted Present Value APV.505. However.4. which is higher than the previous value by 2. The present value of CFE at e under TV WACC assumptions is 31. there is a difference of 376. However.8. which is higher than the previous value by 933. When calc ulating the Adjusted Present Value APV. There are also differences when calculating the market equity value. when the market equity value is calculated from the CFE at e.066. for the same reasons. there differences.996.275. when the market equity value is calculated from the CFE at e. 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 HP WACC is higher is because the difference in tax savings due to the LCF. Another reason is the difference in tax savings due to the LCF.4.765. with the HP WACC.3. with the traditional MM WACC. for the same reason.439. This means a lower WACC. This means a lower WACC.9.1.3.1.225. the present value is $47. with the HP WACC. The results for the second case are summarized in Table 2 Panels A and B.505. which is higher than the previous value by 1.7. the present value is $48.250. 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.8. with the HP WACC. The present value of the FCF at the TV WACC (total market value) is $47. the losses are carried forward and taxes are paid the same year. The reason the present value with the MM WACC is higher is because the discount rate for the tax shield is d. When calculating the Adjusted Present Value APV. When calculating the Adjusted Present Value APV. The reason the present value with the HP WACC is higher is because the difference in tax savings due to the LCF.9. there is no difference. The present value of the FCF at the TV WACC (total market value) is $47.316.The results for the first case are summarized in Table 1 Panels A and B.312.3. with the traditional MM WACC. which is higher than the previous value by 1. the present value is the same.

With the traditional MM WACC. The present value of CFE at e under TV WACC assumptions is 31.395.9. 7 .there differences. the present value is the same.8. the present val ue is $32. which is higher than the previous value by 933.329.9. 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. with the HP WACC.

066.3 31.4 115.2% 0.2 32.3 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. 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%. if precision is desired. TV WACC should be used.225.2% 32.8% 7.312.7 Column (1) of Table 1 (panels A and B) shows the name of the procedure to calculate Total or Equity value.3 47.4% 0. 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) 47.2 115.996.275.5 32.765. Both of them consider e=ρ+(ρ-d)D/E and assume ρ as the correct discount rate for the tax savings.3 3.066.379.debt Equity value = Total value (from CCF at ρ) .1% 4.5 1.291. From columns (4) and (5) it can be seen that in this case TV WACC and HP WACC differ.2% 2.250. The very small differences between TV WACC and HP WACC might show that for practical purposes HP WACC is a good approximation. losses carried forward and taxes paid the same year Total market value.4% 4.3 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) .312.1 1.176.5% Table 1 Panel B.4 31. Columns (4) and (5) show the absolute and relative difference with the TV WACC.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) 47.1 0. Losses. Notice the internal consistency of TV WACC.9 1.489.1 1.181.debt Equity value = PV(CFE @ e) 31.4 253. TS.8% 48. In table 2 the traditional WACC (MM WACC) also shows inconsistencies among the different values and between those values and the TV WACC.In summary Table 1 Panel A.316.debt Equity value = PV(FCF at ρ) + PV(TS at d) . Column (6) shows the values when calculated with the MM WACC.4 253.4 47.319.5 1.2 2. However. 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) 31.2 2.996.0% 33.115.176. losses carried forward and taxes paid the same year Total market value.5 48. Losses. 8 .9 0.429.066.

taxes paid the same year and it is shown that there is no difference.882.9 % over TV WACC (8) 3.0% 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. 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.505.9 (0.84 933.0% Column (1) of Table 2. Both of them consider e=ρ+(ρ-d)D/E and assume ρ as the correct discount rate for the tax savings.505.9 (0.395.9 (0. In Table 1.7 32.0) 0. 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. Notice the internal consistency of TV WACC and HP WACC. Panels A and B.0% 32.8 0.8 47.395. 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) 47.9 47.debt Equity value = PV(CFE at e) 31.2% 3.0) 0.395. No losses.7 376.329.9 1.0% 47. 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.9 (0. No losses.395.0 0. Column (6) shows the values when calculated with the MM WACC.0% 48. In table 2 the traditional WACC (MM WACC) shows inconsistencies among the different values and between those values and the TV WACC. Columns (4) and (5) show the absolute and relative difference with the TV WACC.8 debt Equity value = Total value (from CCF at ρ) .505. 9 .395.9 47.9 % over TV WACC (8) 2.439.9 0.debt 31.9 31.9 31.505.Table 2 Panel A No losses.395.9 31.329. TS.0% 31.8% Difference with TV WACC (7) 933.0) 0.8 Difference with TV WACC (7) 933.0) 0.772.0% Value calculation (1) Equity value = PV(FCF at ρ) +PV(TS at d) .0% 376. shows the name of the procedure to calculate Total or Equity value.

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 24.8 62. PRINGLE. taxes paid the same year.773. They are the MM WACC (the traditional WACC).1 37.022. Frequently.125. Social Science Research Network.6 1.4 26.0 31.654. Conclusions We have shown three approaches to calculate total and equity value with different expressions for WACC.651.5 2.693.378.S. Losses.204.1 1.2 24.1 2.3 1.8 67.4 26.2 38.1 55.000.7 71.3 1.050. The first one produces inconsistent results. terminal value accounts for more that 50% of the total value of the firm.7 43. 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 24.9 1.4 1. the TV WACC.2 63.3 1.534.5 54.733.8 39. The last one.6 55.763.0 47.0 1.7 30.721.2 23.000. Equivalence of the Different Cash Flow Valuation Methods.149. We consider that this is the correct method.953.7 Year 4 30.505.1 37.0 47. Journal of Financial 10 . The second one is consistent as long as there are no losses and/or losses carried forward. HARRIS . losses carried forward and taxes paid the same year.708.110. It can be shown that when taxes are paid the following year after accrual.3 2.Table 3 No losses.395.104.719.030.110.220. R.8 Tables 3 and 4 show the differences in market values when compared with book values. 1985. Although not a formal proof. the only one that gives consistent results is TV WACC. 2000.9 1.J.1 2.4 54. These differences are explained because the financial statements do not consider any terminal value.0 31.3 40. AND J. The equity market values are taken from the calculations made with the TV WACC approach.193.8 67.3 40. “Risk-Adjusted Discount Rates – Extensions from the Average-Risk Case ". PABLO.066.8 Table 4.961.176. the tables give an idea on how much difference is present when the book values are used.8 1.2 38.7 42.9 1. Bibliographic References FERNÁNDEZ .8 39.221.3 1. Working Paper. the HP WACC and the TV WACC.809. produces consistent results either with no losses or losses and losses carried forward.9 71.

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

0% 9.00% Year 0 Year 1 Year 2 Year 3 Year 4 The quantity and increase in the market might be obtained by a marketing research.0% Year 3 40.62% 6.00% 6.00% 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.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. Table A4 Price and increase in price Year 0 Year 1 Purchase price Real price increase Annual increase in purchase price $2.00% 6. Table A2 Market variables Quantity to sell at year t at price given at year 0 Increase in volume 7.01% 1.00% 7. 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% 9. Fisher Theorem is used to compose the three components.00% 10.62% 22.59% 30.00% 11. 12 .00% This information can be obtained from macroeconomic forecasts made by the government or associations or universities.00% 11. the estimated quantity the market will buy.247 0.00% Year 4 6.00% 10.55% 28.00% 5.55% 28.0% 40.95 0.90% 13.64% 12.00% 30.62% 22.59% 28.00% 4.62% 22.10% 0.59% 30.00% 10.55% 28.82% 1.00% Year 2 Year 3 Year 4 The purchase price is a function of Q.59% 30.00% 12.0% Year 4 40.00% 10.55% 22.

11% 11.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 1.80% 0.00 1.76% 12.98% $0.88% 0.60 0.9978 0.30% 11.70% 9. 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. Price increases might be estimated based on historical data of similar firms.32% 3.00 1.00% $0. Effect of price change upon demand.44% $0. It is a function of selling price increase. an elasticity function calculated for the domestic water supply was used.00 1.00 $0.67% 10.60% 9.00% $0.20% 11. or simply a subjective forecast.65% 3.9974 The elasticity function has to be found for the specific product or service we are dealing with.10% 12.32% Year 4 $0.10% 0.00 0.40% 12.00 0.10% 10.55% 3.00 1.00 $0.00 $145.000% 13.20% These are stated on a monthly base.00 $0.00% $0.00 $0. (1-.9971 0.366*((1+increase in selling price)/(1+inflation)-1)) $5.00 $0.00 $0.00 $0.00 $40.90% 9.00 0.00 1.00 1.900% 13.00 1.93% $160.43% $0.60% Year 3 Year 4 0.12% $0.00 $37.30% 12.9996 0.00 Year 1 $0.22% Year 3 $0. Selling price is the result of a market survey and/or the cost structure of the good or service. 13 . In the example.34% 3.01% Year 2 $0.20% 13.00 $0.00% $0.20% 11.00 1.

50 603.66 7. The nominal selling price increase defines the elasticity factor.00% 5.127.00% Year 1 Year 2 Year 3 Year 4 3. the increase in volume and the elasticity factor for the product or service.00% 30.096.36 Units to be sold are based on the initial market survey.00% 5.00 32.000.11 Year 4 8.33% 8.00% 90.00 7.00% 110 120 131 160 160 Many variables are just policies or target the firm will pursue.00% 90.03 These prices are based on the initial selling and purchasing price and the price increase stated above.00% 30.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. 14 .93 674.II 7.00% 5.000.00% 95.17 699.00% 10.33% 24.74 8.00% 10.95 644.00% 3.87 674.33% 95.00 This depreciation is based on the lineal method stated above.00% 3.77 3.74 644.00% 10.00 8.01 3.56 7.33% 8.000.424.000.243.000.56 7.50 8.00 Year 3 8.13 8.00 8.847.399.00 24.79 Year 3 8.53 4.00% 95.00% 30.00 40.000. Table A9 Depreciation Year 1 Year 2 Annual depreciation Cumulative depreciation 8.81 Selling price Buying price 6.00% 90.66 0.000.000.00 16.00% 10. 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 .00% 8. Table A10 Selling and purchasing prices Year 1 Year 2 Year 3 Year 4 7.00% 95.00% 90.774.00% 30.90 603.00% 5.00 3.000.00 Year 4 8.000.733.28 3.

706.000.273.00 11.00 8.78 24.00 16.00 2.50 7.21 41.000.000.149.000.78 38.719.21 3.61 Year 3 2.65 1.00 16.100.055.989.398.534.68 227.26 692.176.00 Year 2 Year 3 Year 4 27.861.11 2.00 16.06 2.39 0.22 214.160.00 32.35 544.534.67% payroll and commissions) Auditing fees Overhead Advertising and promotions These costs are based on the monthly based costs above.34) 23.34 1.70 490.030.33 All the financial statements are linked.583.000.37 2.95 241.44 1.000.966.62 3.726. In this table they are annualized.80 26.206.97 2.00 5.433.39 245.00 2.00 32.15 629.00 24.00 (46.37 159.823.00 (46.110.00 110.890.00 40.953.02 2.45 37.Annual expenses Table A11 Administrative and selling expenses Year 1 Year 2 2.00 12.364.00 8.69 40.574.00 39.000.67 1.00 40.00 8.20 181.66 390.34) 2.00 4.650.000.888.000.082.364.00 4. Net income 15 .00 24.20 40.711.25 1.110.48 2.559.25 2.149.00 24.04 1.000.110.12 612.541.766.88 40.22 Year 4 2.35 1.31 24.38 0.278.267.69 41.000.76 3.000.000.00 2.178.26 196.000.221.000.64 441.22 681. 63 340.30 2.00 0.45 2.41 204.312.719. cash is the same value found in the Cash Budget as cumulative cash balance.449.000.43 37.43 16.66 39.75 2.00 1.14 502.293.28 2.985.393.76 38.147.04 40.076.67 30.00 16.456.027.000.91 24.94 220.457.626.110.68 40.61 186.56 564.95 Administrative payroll Administrative fringe benefits on payroll Sales force payroll Sales commissions Fringe benefits (annual premium 1/12 of payroll) Other fringe benefits (46.626.000. 58 2.11 5.866. For instance.00 8. 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 24.654.91 249.96 1.813.33 3.166.50 15.000.18 8.814.030.12 24.574.654.05 1.0 2.70 0.888.16 2.00 40.61 0.000.719.16 747.03 37.81 270.

340. Sales are simply quantity to be sold times the rice.553. 16 .574.97 8.00 1.30 1.88 37.149.888.37 27.38 0.35 8.68 31.00 24.572.61 7.16 22.286.70 564.267.40 340.149.66 4.61 692.926.25 1. and so on.45 2.000. they appear as a cash outflow at the Cash Budget.796.for the year is the same found in the P&L statement.00 8.450.00 (46.05 5.888.206.00 13.220.04 32.574.988.003.63 5.138.13 4.24 6.954.198.32 390.11 3.706.37 4.738.22 2.95 2.57 1.77 3.479.600.931.217.940.37 1.364.69 30.11 2.664.34) 54.65 8.03 62.723.40 19.682.669.20 27.243.50 441. 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 45.452.39 502.61 2.150.293.44 5.456.755.480.34 8.11 2.966.982.293.00 1.89 2.31 2.626.364.00 (46.00 2.67 The figures for the P&L statements are based on the forecasts above.823.626.178.62 22.93 33.300.788. Items such as taxes will appear in the Balance Sheet in case taxes are paid the following year.000.00 3.97 2.890.38 5.34) 0.97 1.38 1.393.15 2.748.631.80 Year 3 Year 4 71. There is no plug. etc.00 1.44 8.890.95 15.75 1.68 26.38 629.16 21.705. In this case.595.000.22 10.79 18.65 490.598.20 22.988.000.76 1.265.52 2.04 33.

66 2.95 220.00 2.72 4.205.37 1.35 40.982.33 22.705.985.96 51.76 30.100.34 1.37 1.00 3.669.32 502.149.40 5.966.00 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 43.664.504.93 24.000.02 50.421.456.115.95 0.450.69 43.97 3.61 1.509.783.60 0.39 30.228.00 0.61 0.00 4.988.50 2.00 0.67 71. It is a financing decision that will be made with the cash balance below.50 6.670.300.147.711.00 1.205.00 680.65 2.00 36.273.03 68.940.62 56. It does not include loans income.71 196.63 17 .340.02 59.34 2.598.50 3.766.702.000.72 In this table all the cash inflows are registered.30 441.65 3.081. Table A15 Cash budget: Cash outflows Cash outflows Suppliers Payments for purchases year 1 24.72 24.436.26 24.00 22.206.115.67 71.32 27.65 390.98 1.44 33.00 1.553.44 2.000.769.89 Payments for purchases year 4 33.504.57 Payments for purchases year 2 27.888.64 2.205.600.31 62.220.626.16 54.79 245. It takes into account the accounts receivables policy stated above.27 1.00 43.480.32 2.972.452.364.228.479.457.37 62.69 71.11 Year 0 Year 1 Year 2 Year 3 Year 4 1.43 43.00 0.149.94 27.000.25 340.888.595.210.22 2.39 564.70 629.572.75 5.689.22 2.359.Cash inflows Table A14 Cash budget: Cash inflows Year 0 Year 1 45.20 53.903.63 1.003.20 53.589.00 1.364.35 2.783.20 2.313.902.45 Payments for purchases year 3 31.15 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 40.31 62.97 1.793.706.44 5.150.38 692.626.

702.811.677.00 2.02 50.This table shows all the cash outflows.06 16.00 110.79 8.783.78 12. 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 23.841.312. These are.421.20 53.63 6.71 0.00 36.027.78 9.62 56.72 (16.228.756.00 Year 2 Year 3 Year 4 24.027.000.526.00 40.50 8.62 27.783.00 0.00 0.50 0.972.28 5.67 71. These are included below.29 12.000. It does not include loans payment.00 0.31 62.56 20.00) 16.10% 0.00 43.00 4.00 4.12 31.000.21 This table shows the information from the Cash Budget in order to make the financing decisions.205.00 4.00) (16.650. how much should beborrowed and how much can be paid with the available cash. 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. 18 .11% 10.893.191.027.498.43 43.55 10.110.866.339.28 2.1 6.59 0.163.50 0.313.813.027.783.50 0.00% This table shows the growth and discount rate for determining the terminal value .000.504.05 14.

00 Year 3 Year 4 Year 5 8.383.39 96.00 680.627.00 4.783.912.29 6.50 2.05 8.00 4.327.36 11.251.50 91.00 1.027.756. the cost before and after taxes calculated as the IRR of the CFD before and after taxes.50 14.89 14.407.00 0.00 0. We do not use the approach to calculate FCF from EBIT or net profit because this method increases the probability of errors.717.383.55 96.600.00 11.00 (920. the CFE.50 3.00 0.881.300.00 (1.163.00 0.39 16.682. 19 .150.843.13% 8.756.60 0.964.78 6.55 10.5 17.28 11.627.407.79 0.39 5.027.00) (460.69 18.682.5 5.843.34 1.50 4.28 0.05 The FCF is calculated from the Cash Budget.177.5 6.682.28 Year 2 5.769.553.00 0.78 11.498. starting from EBIT might introduce errors in the tax paid and the tax savings earned.00) 0.881.05 4.50 5.450.50 96.881.717.783.783.464.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) 2.79 11. In particular.55 4.251.383.00 4.251.027.89 Year 4 91.383.5 7.00 0.097.55% 11.50 11.29 14.50 4.756.00) 0.50 8. 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 2.78 11.50 2.027.79 Year 3 8.964.097.627.251.78 8.00 Year 2 5.881. Cost of debt is assumed constant.39 This table shows the CFD.13 (Plus) 79.29 5.50 28.477.59 0.380.29 14.

39 71.380.881.13% 0.2736 96.40% 25. 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. First.55% 40.15% 25.50 0 3.261.682.85 13.027.30 Year 3 Year 4 36.733.05 This information is common for the three methods.027.75% 71.00% 28.027.176.00 40.627. It has to be remembered that there exists circularity and this is the result of iterations done by the spreadsheet.55% 38.00 4. we determine how much TS is earned according to the financial situation of the firm.50 40.00 4.220. We do not calculate the TS straightforward with the formula TdD.00% 28.The next tables show the calculation of market values and the three different approaches to calculate WACC.055.50 7.00 40.00% 28.383.383.00 1.50 460.027.55% 36.00 24.176. 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 47.85 36.18% 35.220.65% 25.78 54.150.450. we present the TV WACC approach.000.110.34 11.142. This is.TS/Total value at t-1 Market Total Value at t @ WACC 40.29 62.177.34 54.327.600.50 Year 4 40.61 In table the resulting WACC and market values are shown.082.13% 0.50 920.05 20 .5137 11.78 12.027.3732 14.763.61 Year 4 97.00% 28. TS are calculated in an explicit way.50 1.15% 47.39 4.00 40.38% 62. except for the tax savings TS.29 8.00 4.300.30 15.55% 37.110.251.171.477.13% 0. With the TV WACC approach.00 4.90% 25.50 6.733.00 4.7135 11.763.00 2. Table A21 TV WACC and market value calculations Year 0 Year 1 Year 2 WACC after taxes = ρ .50 5.13% 0.50 8.

55% 36.027.849.682.176.00 3.110. In this table the market value is calculated directly with the CCF and ρ.50 7.450.027.12 61.22 1.00 2.39 Year 4 337.55% 40.79 42.50 460.39 4.00 4. 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) 16.193.28 31.13% 0.25 70.99% 8.383.00 24.251.00 40.50 6.13% 0.964.998.30 36.00 40.83% 5.708.00% 28. Table A23 APV and market value calculations Year 0 Year 1 Year 2 Year 3 PV(FCF at ρ ) PV(TS at ρ ) Total 45.55 67.2736 96.881.066.87% 91.50 40.756.150.55% 38.73 1.13% 0.00% 28. TS are calculated in an explicit 21 .843.00 4.380. It has to be remembered that there exists circularity and this is the result of iterations done by the spreadsheet.110.50 1.36 Capital cash flow and APV with the TS discounted at ρ.65% 25.55% 37. are the same.05 This information is common for the three methods.00 4.600.7135 11.11 53.082.3732 14.00 4.5137 11.40% 25.50 1.651.Capital cash flow is defined as CCF = FCF + TS. In the following tables the HP WACC approach is presented. except for the tax savings TS.082. 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. With the TV WACC approach.00 40.11 In table the resulting e and equity market values are shown.13% 0.29 8.50 920. Table 24 CFE.027.178.15% 25.627.89 54.50 8.34 45.50 Year 4 40.00 1.00 4.327.027.651.34 41.11 47.178.16% 2.91 913.055.22 1.477.00% 28.000.883.840.300.78 12.027.177.998.35 38.90% 25.00% 28.50 5.783.

6% 62.489.324.78 48.73 1.62% 2.22 2. The HP WACC is calculated based on the contribution of each: the debt and the equity. It has to be remembered that there exists circularity and this is the result of iterations done by the spreadsheet.223.07% 12.07% 22.93% 46.28% Year 1 Year 2 Year 3 Year 4 In table the resulting WACC and market values are shown.08% 39.92% 22.36 337.1% 34.490.62% 1.998.99 48.39 Year 4 70.291.998.30 97. Table A28 APV and market value calculations Year 0 PV(FCF at ρ ) PV(TS at ρ ) Total 45.9% 71.082.261.39 62.489.12 Year 3 61.33% 36. In this table the market value is calculated directly with the CCF and ρ.29 54.22 2.849.71% 22. 22 .94 77.92% 5.45 94. we determine how much TS is earned according to the financial situation of the firm.171.490.939.85 15.61 Capital cash flow is defined as CCF = FCF + TS.42% 38.78% 36.96% 36. This is.way.220.651.763.11 87.1% 53.60% 41.883.87% 34.14% 30.22 Year 1 45.91 913.99 Year 2 53.00% 33.22 13.25 Capital cash flow and APV with the TS discounted at ρ.50% 37. In this case we calculate the TS straightforward with the formula TdD. 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 13.058.05 71.62% 7.733.40% 22. are the same.47 65.88% 32.142.67% 22. 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 47.62% 5.

55 In table the resulting e and equity market values are shown.65% 25.192.600.00 40.29 8.00% 28.682.110.027.55 67.110.477.3732 14.00% 28.627.55% 37.00 3.15% 25.50 7. TS are calculated in an explicit way. In this case we calculate the TS straightforward with the formula TdD.Table 29 CFE.7135 11.027.50 40.316.00% 28.90% 25.63 Year 4 91.55% 38.55% 36. 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) 16.881.840.00 4.79 42. we determine how much TS is earned according to the financial situation of the firm.39 4.082.383.450.5137 11.50 Year 4 40.027.631.00 2. and market value of equity calculation with CFE at e Year 0 CFE=FCF+TS-CFD PV(CFE at e) 32.50 8.783.00 40.00 24.150.027. This is.703.843.177.50 1.251.13% 0.964.00 4. It has to be remembered that there exists circularity and this is the result of iterations done by the spreadsheet. With the TV WACC approach.40% 25.055. 23 .05 This information is common for the three methods.300.00 4.43 Year 1 4.43 Year 2 5.50 5.00 4.50 1.000.316.13% 0.28 32. Now.50 460.78 12.596.89 54.380.2736 96.00 4.13% 0.55% 40.327. the MM WACC approach is presented.36 Year 3 8.50 6.50 920. except for the tax savings TS.00 40.027.00 1.00% 28.13% 0.

17% 22.3 47.201.62% 5.41% 22.7 1.082.62% 1.431.64% 29.275.429.06% 36.2 1. The FCF is discounted at ρ and the TS is discounted at d.89 54.62% 2.02% 12.40 In table the resulting e and equity market values are shown.62% 7.604.28% Year 1 Year 2 Year 3 Year 4 In table the resulting WACC and market values are shown.8 In this case. and market value of equity calculation with CFE at e Year 0 CFE=FCF+TS-CFD PV(CFE at e) Year 1 4.27 87.51% 36.073.5 Year 3 61. Table A32 APV and market value calculations Year 0 PV(FCF at ρ ) PV(TS at d) Total 45.4% 71.34% 36.56% 22.72 Year 2 5.151.4 357. It has to be remembered that there exists circularity and this is the result of iterations done by the spreadsheet.501. 24 .66 Year 4 91. The HP WACC is calculated based on the contribution of each: the debt and the equity.59 77.783.998.431.985.55 67.41 66.79 43.849.9% 33.87% 22.998.5 Year 1 45.3 Year 2 53.843.13% 38.91% 5.60% 35.225.66% 22.9 715.83% 40.67% 31.7 Year 4 70.2 1.596.59% 43.6% 54. Table 33 CFE.7% 62.883.45% 33.68% 34.28 33.08 94.04 Year 3 8.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. It has to be remembered that there exists circularity and this is the result of iterations done by the spreadsheet.65% 36. the CCF does not have any meaning.964.285.

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