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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

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

based on the first assumption. This paper studies this problem. for the firm at the Weighted Average Cost of Capital and subtracting the debt or discounting the cash flow to equity holders CFE. Second. 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. These two values are not equal. It is expresse d as WACC = eE% + d(1-T)D% (1) Where e is the cost of equity. If there are LCF neither of the two expressions for WACC works. current practice find that this does not happens. measures this future value.Discounting the free cash flow FCF. Then the correct WACC proposed by Tham & Velez (TV) is TV WACC = ρ – TS/(Total levered value) (4) 3 . 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. the expression for e does not include (1T). e = ρ + (ρ – d)D%/E% (3) In practice we encounter losses carried forward (LCF). 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. The problem lies in what is the correct discount rate to be used to discount the cash flows. D% is the proportion of debt in total value and T is tax rate. this traditional formulation does not work in the finite period cash flows. Unfortunately. In the traditional presentation. We will examine the WACC proposed by Harris and Pringle (1985) and we call it the HP WACC. 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. the discount rate for the tax shield is ρ. First. Some background on WACC In the literature we find the traditional presentation for WACC for discounting the FCF excluding tax savings from interest payments. This HP WACC differs from the MM WACC in two significant ways. at the cost of equity. E% is the proportion of equity in the total value. In a M & M world. We will call this the MM WACC. these two values must be equal. However. This is.

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

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

3.3. which is higher than the previous value by 1.066.9.505.9. There are also differences when calculating the market equity value. with the HP WACC.3.176. where we assume that there are no losses and taxes are paid the same year. which is higher than the previous value by 2.996. when the market equity value is calculated from the CFE at e. with the traditional MM WACC. The reason the present value with the MM WACC is higher is because the discount rate for the tax shield is d.4. The present value of the FCF at the TV WACC (total market value) is $47.316. the present value is $33. which is higher than the previous value by 933.9.439.8. which is higher than the previous value by 1. lower than ρ.765. for the same reason. Another reason is the difference in tax savings due to the LCF. The present value of the FCF at the TV WACC (total market value) is $47. The results for the second case are summarized in Table 2 Panels A and B. with the HP WACC. The reason the present value with the HP WACC is higher is because the difference in tax savings due to the LCF.4. for the same reasons. with the traditional MM WACC.9.8. 6 .275.312. the losses are carried forward and taxes are paid the same year. However. 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 present value is $48.3.5. with the HP WACC.225. However. There are also differences when calculating the market equity value. there differences. there is a difference of 253. the present value is $47.176. the present value is $32. The reason the present value with the HP WACC is higher is because the difference in tax savings due to the LCF. This means a lower WACC.291. 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. With the traditional MM WACC. the present value is the same. When calculating the Adjusted Present Value APV. The differences are the same when calculated as Total value less debt.The results for the first case are summarized in Table 1 Panels A and B.1. When calc ulating the Adjusted Present Value APV. which is higher than the previous value by 115. there is no difference. The differences are the same when calculated as Total value less debt. The present value of the FCF at the TV WACC (total market value) is $47.4. The present value of the FCF at the TV WACC (total market value) is $47. where we assume that there are losses.7. The present value of CFE at e under TV WACC assumptions is 31. there is a difference of 376.250. When calculating the Adjusted Present Value APV.1. This means a lower WACC.2. the present value is $48.505. for the same reason. when the market equity value is calculated from the CFE at e. there is a difference of 1. When calculating the Adjusted Present Value APV.

9.9. The present value of CFE at e under TV WACC assumptions is 31. the present value is the same. 7 . With the traditional MM WACC. with the HP WACC. 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 present val ue is $32.395. which is higher than the previous value by 933.8.329.there differences.

1% 4.250. 8 .176.1 1.3 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. Notice the internal consistency of TV WACC. if precision is desired.8% 48.5 48.765.066. 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) 47.3 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) . Losses.1 0.In summary Table 1 Panel A.5 32.176.8% 7.5 1.319.066.4% 0.2% 2. 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. In table 2 the traditional WACC (MM WACC) also shows inconsistencies among the different values and between those values and the TV WACC.9 1. 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.275. Column (6) shows the values when calculated with the MM WACC.2 115.181.5% Table 1 Panel B.debt Equity value = Total value (from CCF at ρ) .4% 4. 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%.115.429.2 32. losses carried forward and taxes paid the same year Total market value.debt Equity value = PV(FCF at ρ) + PV(TS at d) . TV WACC should be used.4 31. losses carried forward and taxes paid the same year Total market value. Both of them consider e=ρ+(ρ-d)D/E and assume ρ as the correct discount rate for the tax savings. The very small differences between TV WACC and HP WACC might show that for practical purposes HP WACC is a good approximation.4 253.3 3. TS.4 253.379.5 1.9 0.312.debt Equity value = PV(CFE @ e) 31.225.996.4 115. Losses. From columns (4) and (5) it can be seen that in this case TV WACC and HP WACC differ.489.066.291.3 31.2 2.2 2. Columns (4) and (5) show the absolute and relative difference with the TV WACC.312.316.3 47.2% 0.2% 32.1 1.4 47.7 Column (1) of Table 1 (panels A and B) shows the name of the procedure to calculate Total or Equity value.3 31.996.0% 33. However.

9 (0.505.329.9 % over TV WACC (8) 2.772.0% 47.Table 2 Panel A No losses. 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.0) 0.7 32. TS.9 47.9 47. 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) 31.329. Column (6) shows the values when calculated with the MM WACC. 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) 47.882.8 Difference with TV WACC (7) 933.9 % over TV WACC (8) 3.0% 48.395.395.395.0% 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.8 0. taxes paid the same year and it is shown that there is no difference.8% Difference with TV WACC (7) 933.84 933. Columns (4) and (5) show the absolute and relative difference with the TV WACC.505.439. Both of them consider e=ρ+(ρ-d)D/E and assume ρ as the correct discount rate for the tax savings.0% Value calculation (1) Equity value = PV(FCF at ρ) +PV(TS at d) .0% 32.9 (0.9 (0.0% 31.7 376.9 (0. In Table 1.debt 31.0% 376.0) 0.8 debt Equity value = Total value (from CCF at ρ) .0) 0.395.9 31.2% 3.0 0. No losses. Notice the internal consistency of TV WACC and HP WACC.0) 0. 9 . In table 2 the traditional WACC (MM WACC) shows inconsistencies among the different values and between those values and the TV WACC.8 47.9 1.9 31.395.395.debt Equity value = PV(CFE at e) 31.505.0% Column (1) of Table 2. shows the name of the procedure to calculate Total or Equity value.505. Panels A and B.9 31. No losses. 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.

Journal of Financial 10 .1 37.763.193.0 47.125.8 1.110.0 1. terminal value accounts for more that 50% of the total value of the firm. the tables give an idea on how much difference is present when the book values are used. Conclusions We have shown three approaches to calculate total and equity value with different expressions for WACC.708.2 63.8 62.7 Year 4 30.8 Table 4. “Risk-Adjusted Discount Rates – Extensions from the Average-Risk Case ".7 71. AND J.176.7 42.733. Working Paper.066. R. Equivalence of the Different Cash Flow Valuation Methods.395.022. The equity market values are taken from the calculations made with the TV WACC approach.2 38. Bibliographic References FERNÁNDEZ .378.0 31.0 47.Table 3 No losses.0 31. 1985.8 67.110.651. the only one that gives consistent results is TV WACC.8 67.4 54.719.4 1.000.3 1. Social Science Research Network.9 1. The second one is consistent as long as there are no losses and/or losses carried forward. PABLO.4 26.3 1.9 1.3 1.7 30. It can be shown that when taxes are paid the following year after accrual. These differences are explained because the financial statements do not consider any terminal 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 24.809.3 40.693.961.1 37.4 26.8 39.3 1. produces consistent results either with no losses or losses and losses carried forward. 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.J.9 71.221. We consider that this is the correct method.1 2.5 2.6 55.1 55.8 39. taxes paid the same year.505.953.1 2. the TV WACC. Frequently. Although not a formal proof.8 Tables 3 and 4 show the differences in market values when compared with book values.6 1. Losses. The first one produces inconsistent results.050.773.9 1.3 40.149. They are the MM WACC (the traditional WACC).2 24.2 38.7 43.104. HARRIS .5 54. The last one.030.000.220. the HP WACC and the TV WACC.721.S.204. PRINGLE.534.3 2. 2000.1 1. losses carried forward and taxes paid the same year.654.2 23.

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

90% 13. the estimated quantity the market will buy.10% 0.55% 28.62% 22.0% 9. 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% 10.0% Year 3 40.00% Year 4 6.59% 30.62% 22.00% 12.62% 6.00% 30.247 0.00% This information can be obtained from macroeconomic forecasts made by the government or associations or universities.00% 10.00% 10.00% 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. 12 .62% 22.00% 11. Table A4 Price and increase in price Year 0 Year 1 Purchase price Real price increase Annual increase in purchase price $2.00% 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 4 40.64% 12.00% Year 2 Year 3 Year 4 The purchase price is a function of Q.95 0.00% 9.55% 28.00% 6.00% 6.55% 22.82% 1.00% 10.55% 28.01% 1.00% 7.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. Fisher Theorem is used to compose the three components.59% 30. Table A2 Market variables Quantity to sell at year t at price given at year 0 Increase in volume 7.0% 40.59% 28.59% 30.00% 4.00% 5.00% 11.

00 $0. It is a function of selling price increase.10% 12.00 1.00 1.00% $0.00 1.00 1.00 $0.10% 0.00 $0.32% 3.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 1.00 $0.00% $0.00 $40. 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 56.00 Year 1 $0.9974 The elasticity function has to be found for the specific product or service we are dealing with.90% 9.93% $160.00 $0.30% 12. Effect of price change upon demand.12% $0.76% 12.70% 9. an elasticity function calculated for the domestic water supply was used.22% Year 3 $0.900% 13. In the example.34% 3.366*((1+increase in selling price)/(1+inflation)-1)) $5.20% 13.000% 13.00 0. Selling price is the result of a market survey and/or the cost structure of the good or service.43% $0.11% 11.88% 0.98% $0. (1-. 13 .00 $0.10% 10.20% 11.55% 3.01% Year 2 $0.00 $0.65% 3.00 $37.67% 10.00 1.32% Year 4 $0.00 0.20% These are stated on a monthly base.00 1.00 0.9978 0. or simply a subjective forecast.30% 11.20% 11.9996 0.00 $0.00% $0.00 1. Price increases might be estimated based on historical data of similar firms.80% 0.60% Year 3 Year 4 0.00 $145.60% 9.44% $0.00% $0.9971 0.40% 12.00 1.60 0.

36 Units to be sold are based on the initial market survey.096.56 7.00% 10.00 16.00% 90.93 674.00% 30.399.33% 8.33% 24.50 8.00 7.000.28 3.000. the increase in volume and the elasticity factor for the product or service.00% 90.00 8.74 644.00 3. Table A9 Depreciation Year 1 Year 2 Annual depreciation Cumulative depreciation 8.000.95 644.000. Table A10 Selling and purchasing prices Year 1 Year 2 Year 3 Year 4 7.774.II 7.00% 10.000.127.01 3.33% 95.00% 95.000.000.56 7.00% 3.00% 3.66 0.000. 14 .03 These prices are based on the initial selling and purchasing price and the price increase stated above.00 Year 4 8.00 24.53 4.77 3.00% 8.50 603.00 40.13 8.00% 30.00% 5.90 603.33% 8.847.00 Year 3 8.00% 90.000.00 This depreciation is based on the lineal method stated above.00 32.00% 5.000.81 Selling price Buying price 6.66 7.424.00% 110 120 131 160 160 Many variables are just policies or target the firm will pursue.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. The nominal selling price increase defines the elasticity factor.243.00% Year 1 Year 2 Year 3 Year 4 3.00% 5.11 Year 4 8.00% 30.00 8.00% 95.00% 5.00% 10.00% 95. 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% 10.733.79 Year 3 8.17 699.74 8.87 674.00% 30.00% 90.

000. cash is the same value found in the Cash Budget as cumulative cash balance.00 16.719.000.43 16.00 (46.055.35 544.61 0.766.000.000.41 204.398.22 214.989.719.176.78 24.28 2.00 12.711.000.00 16.706.030.61 186.00 40.823.000.97 2.00 (46.69 41.91 249.67 1.76 38.000.16 747.888.206.030.364.293.813.81 270.00 39.21 41.00 8.221.000.14 502.364.62 3.433.Annual expenses Table A11 Administrative and selling expenses Year 1 Year 2 2.00 24.110.149.94 220.00 5.393.50 7.953.37 159.69 40.449.11 5.160.00 4.12 24.88 40.000.34 1.00 8.273.149.178.21 3.18 8.56 564.000.70 0.95 241.02 2.000.00 40.43 37.22 681.35 1.64 441.04 1.50 15.00 2.12 612.890.000.00 8.30 2.027.91 24.814.110.147.15 629.00 40.861.16 2.38 0.00 0.267.000.457.626.65 1.00 2.888.574.082.26 692. Net income 15 .45 37.456.00 1.534.650.67 30.719.00 110.22 Year 4 2.61 Year 3 2. 58 2. 63 340.000.541.70 490.06 2.000.37 2.654.76 3.78 38.33 3.03 37.20 181.110.26 196.44 1.866.00 32.00 32.00 Year 2 Year 3 Year 4 27.11 2.96 1.000.20 40.312.66 390.00 16.25 2.00 24.100.966.33 All the financial statements are linked.00 24. For instance.34) 2.68 40.0 2.66 39.000.95 Administrative payroll Administrative fringe benefits on payroll Sales force payroll Sales commissions Fringe benefits (annual premium 1/12 of payroll) Other fringe benefits (46.583.00 2.67% payroll and commissions) Auditing fees Overhead Advertising and promotions These costs are based on the monthly based costs above.000.076.48 2.985.574.04 40.45 2.534.00 4.626. 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 24.75 2.654.05 1.34) 23.25 1.39 245.726.110.000.00 11.39 0.278. In this table they are annualized.00 8.80 26.68 227.559.166.00 16.000.31 24.

000.89 2.39 502.04 33.70 564.68 26.574.00 1.206.000. There is no plug.600.16 21.198.480.40 340.93 33.000.988.16 22.286.32 390.940.340.00 8.267.57 1.50 441.66 4.24 6.61 7.05 5.243.80 Year 3 Year 4 71.479.450.11 3.04 32.220.748.982.626.890.364.38 629.888.38 0.705.97 1.37 4.31 2.for the year is the same found in the P&L statement.926.52 2.00 3.77 3.20 22.823.788.15 2.22 10.69 30.452.574.22 2.738.97 2.796.35 8.300.40 19.293.00 1.293.65 490.595.954. and so on.626.63 5.988. In this case.682.30 1.11 2.38 1.178.138.553.34) 0.723.00 1.34) 54.00 24.706.149.00 (46.217.11 2.598.755.00 (46.79 18.393.00 13.966.67 The figures for the P&L statements are based on the forecasts above.13 4.45 2.631.20 27.61 692.62 22. 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 45.38 5.95 2.75 1. 16 . Items such as taxes will appear in the Balance Sheet in case taxes are paid the following year.34 8.97 8.572.37 1.888.664.95 15.61 2.65 8.88 37.37 27.000.44 8.76 1. etc.150.149.00 2.03 62. Sales are simply quantity to be sold times the rice.890.265.669.44 5.931.364. they appear as a cash outflow at the Cash Budget.003.68 31.25 1.456.

65 2.97 3.33 22.76 30.57 Payments for purchases year 2 27.436.Cash inflows Table A14 Cash budget: Cash inflows Year 0 Year 1 45.359.35 40. It is a financing decision that will be made with the cash balance below.000.00 1.39 30.940.95 0.69 43.00 1.31 62.63 1.888.32 502.150.20 53.32 27.64 2.149.32 2. It takes into account the accounts receivables policy stated above.72 4.45 Payments for purchases year 3 31.26 24.62 56.35 2.61 0.598.37 1.205.69 71.300.003.97 1.71 196.689.705.00 22.44 2.985.61 1.25 340.966.504.479.03 68.34 1.115.93 24.783.589.70 629.595.220.888.000.94 27.147.149.982.39 564.115.457.30 441.572.793.75 5.669.702.72 In this table all the cash inflows are registered.456.43 43.63 17 .65 3.50 6.711.081.34 2.600.38 692.72 24.22 2. Table A15 Cash budget: Cash outflows Cash outflows Suppliers Payments for purchases year 1 24.205.27 1.67 71.98 1.988.766.67 71.20 53.16 54.50 2.228.89 Payments for purchases year 4 33.00 680.00 0.44 33.00 0.00 1.903.00 43.480.22 2.96 51.664.340.452.000.902.706.00 36.364.228.31 62.60 0.313.37 62.972.02 50.44 5.11 Year 0 Year 1 Year 2 Year 3 Year 4 1.40 5.670.783.273.79 245.100.15 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 40.421.769.626.509.206.364.95 220.02 59.50 3.205.00 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 43.450.00 0.210.65 390.00 4.20 2.00 3.66 2.504.553.626.37 1.00 2. It does not include loans income.000.

56 20.11% 10.20 53.72 (16.312. These are.027.972.813.205.02 50.78 12.28 2.677.756.00 4.504.841.027.526.63 6.00 40.027.000.421.00 0.783. 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 110.313.00 4.191.339. how much should beborrowed and how much can be paid with the available cash.79 8.00 36.163.498.50 0.866.228.59 0.00 43.783.000.702.This table shows all the cash outflows.027.67 71.00) (16.1 6.000. 18 .12 31.21 This table shows the information from the Cash Budget in order to make the financing decisions.00 4.650.31 62.50 0.00 2.000.110. 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 23.00 0.00) 16.78 9.43 43.00 4.05 14.50 8. These are included below.06 16.10% 0.811.00 110.28 5.00 Year 2 Year 3 Year 4 24.55 10.71 0.62 27. It does not include loans payment.00% This table shows the growth and discount rate for determining the terminal value .50 0.62 56.29 12.783.893.00 0.

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 5.39 16.50 3.600.50 2.00) 0.843.50 8.027.383.78 11.00 0.177.00) 0.34 1. the cost before and after taxes calculated as the IRR of the CFD before and after taxes.00) (460.097.55 4.50 2.78 8.627.964.13% 8.79 Year 3 8. Cost of debt is assumed constant.5 7.383. In particular.39 96.05 8.59 0.5 5.36 11.89 Year 4 91.50 11.00 11.50 14.55 10.964.50 96.28 11.50 91.380.00 680.00 (920.5 17.682.756.00 4.383.881.327.881.29 5.717.251.783.251.60 0.881.027.682.00 Year 2 5.027.55% 11. 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. the CFE.00 0.150.00 0.79 11.28 0.50 4.13 (Plus) 79. starting from EBIT might introduce errors in the tax paid and the tax savings earned.717.29 6.407.783.28 Year 2 5.163.450.756.00 0. We do not use the approach to calculate FCF from EBIT or net profit because this method increases the probability of errors.00 4.00 4.756.05 The FCF is calculated from the Cash Budget.912.78 6.69 18.477.251.29 14.50 4.251.464.79 0.300.627.627.78 11.5 6.39 This table shows the CFD.39 5.783.00 (1.097.05 4.769.027.29 14.89 14. 19 .383.498.682.55 96.843.00 0.553.00 1.407.881.00 Year 3 Year 4 Year 5 8.00 0.50 28.

05 20 .61 Year 4 97.110.00 4.90% 25.34 54.477.55% 37.78 54.251.763.85 36.300.027.00 4.50 6.7135 11.027. 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 47.39 71.055.00 4.15% 25.13% 0.50 8.176.30 15.50 5.171.5137 11.13% 0.85 13.150.261.13% 0.682. we determine how much TS is earned according to the financial situation of the firm.30 Year 3 Year 4 36.763.50 0 3.18% 35.13% 0.65% 25. TS are calculated in an explicit way.082.600.00 2.733.3732 14.00 4.50 1.627. This is.50 920.39 4.00% 28.55% 36. we present the TV WACC approach.881.34 11.50 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) 16.61 In table the resulting WACC and market values are shown. It has to be remembered that there exists circularity and this is the result of iterations done by the spreadsheet.00 40.75% 71.50 7.55% 40. We do not calculate the TS straightforward with the formula TdD. except for the tax savings TS.00% 28.327. With the TV WACC approach.027.177.00 4.220.027.55% 38.The next tables show the calculation of market values and the three different approaches to calculate WACC.05 This information is common for the three methods.110.29 62. Table A21 TV WACC and market value calculations Year 0 Year 1 Year 2 WACC after taxes = ρ .142.15% 47.733.383.29 8.00% 28.TS/Total value at t-1 Market Total Value at t @ WACC 40.78 12.00 1.00 40.00 40.2736 96.450.027. First.380.40% 25.220.00 24.38% 62.00% 28.000.50 Year 4 40.50 460.176.383.

39 4.11 53.50 40.50 460. TS are calculated in an explicit 21 .027.89 54.00% 28.327.998. 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. 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) 46.082.840.55% 36.027.027.55% 40.12 61.00 4.082.40% 25.00 4.066. 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) 16.00 4.998.150.15% 25.00 3.36 Capital cash flow and APV with the TS discounted at ρ.110.11 In table the resulting e and equity market values are shown. With the TV WACC approach.251.193.027.05 This information is common for the three methods.30 36. are the same.50 8.178.177.477. It has to be remembered that there exists circularity and this is the result of iterations done by the spreadsheet.843.110.00 2.22 1.450.13% 0.849.55% 37.79 42.383.34 41.178.682.300.99% 8.39 Year 4 337.651.651.22 1.Capital cash flow is defined as CCF = FCF + TS.28 31.883.13% 0.29 8.00% 28.50 Year 4 40.91 913.83% 5. In the following tables the HP WACC approach is presented.87% 91.65% 25.000.380.34 45.176.055.00% 28.00 40.00% 28.50 6.756. except for the tax savings TS.00 40.25 70.50 5.35 38.2736 96.783.55 67. Table 24 CFE.50 1.7135 11.13% 0.73 1.13% 0.5137 11.881. In this table the market value is calculated directly with the CCF and ρ.600.50 1.627.55% 38.00 1.00 4.50 920.027.00 4.90% 25.50 7.11 47.00 24.3732 14.964.708.78 12.16% 2.00 40.

91 913.40% 22.489.291.73 1.07% 22.33% 36.67% 22.12 Year 3 61.849.883.08% 39.223.99 Year 2 53. It has to be remembered that there exists circularity and this is the result of iterations done by the spreadsheet.651.22 Year 1 45.082.85 15.490.25 Capital cash flow and APV with the TS discounted at ρ.92% 22.45 94.42% 38.92% 5.62% 1.00% 33.78 48. 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 13.36 337.324. Table A28 APV and market value calculations Year 0 PV(FCF at ρ ) PV(TS at ρ ) Total 45. we determine how much TS is earned according to the financial situation of the firm.71% 22.22 13. are the same.78% 36.22 2.220.1% 53.99 48.96% 36. 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.way.87% 34.62% 5.94 77.9% 71.142.763.14% 30.88% 32.11 87.29 54.39 Year 4 70.058.939.61 Capital cash flow is defined as CCF = FCF + TS. The HP WACC is calculated based on the contribution of each: the debt and the equity.171.62% 2.733.1% 34.6% 62. In this case we calculate the TS straightforward with the formula TdD. 22 .261. This is.28% Year 1 Year 2 Year 3 Year 4 In table the resulting WACC and market values are shown.489.60% 41.22 2.998.07% 12.05 71.998.50% 37. In this table the market value is calculated directly with the CCF and ρ.39 62.30 97.490.47 65.62% 7.93% 46.

55% 40.00 4.783.00% 28.50 460. and market value of equity calculation with CFE at e Year 0 CFE=FCF+TS-CFD PV(CFE at e) 32.840.39 4.50 Year 4 40. except for the tax savings TS. 23 .000.682. Now.50 8.55% 36.00 4.00 40.50 40.00 4.192.00 4.251.00 1.28 32.110.055.13% 0.477.027.55% 38.05 This information is common for the three methods. TS are calculated in an explicit way.600.843.027.36 Year 3 8.596.43 Year 1 4.00 40.703.00% 28.027. It has to be remembered that there exists circularity and this is the result of iterations done by the spreadsheet.15% 25.50 1.40% 25.00% 28.90% 25.150. In this case we calculate the TS straightforward with the formula TdD.50 5.00 40.89 54. the MM WACC approach is presented.13% 0.Table 29 CFE.00 3.2736 96. With the TV WACC approach.631.450.7135 11.65% 25.55 67.50 920.3732 14. we determine how much TS is earned according to the financial situation of the firm.13% 0.316.964.177.55% 37.63 Year 4 91.43 Year 2 5.027.50 7.50 6.79 42.380.110.13% 0.00 4.29 8.316.300.00 2.50 1.55 In table the resulting e and equity market values are shown.082.027.327.78 12.383.5137 11.00 24. This is.00% 28.881. 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) 16.627.

849.28% Year 1 Year 2 Year 3 Year 4 In table the resulting WACC and market values are shown.9% 33.883.56% 22.62% 5.27 87.66% 22.431.2 1.4 357.28 33.8 In this case. Table 33 CFE.87% 22.7 1.45% 33.62% 2.3 47.225.04 Year 3 8.082.964.9 715.83% 40.5 Year 3 61.08 94.7% 62.59 77.40 In table the resulting e and equity market values are shown.3 Year 2 53.66 Year 4 91.91% 5.4% 71.2 1.501.431. The FCF is discounted at ρ and the TS is discounted at d.201.89 54.783.7 Year 4 70.59% 43.02% 12.60% 35.6% 54.596. The HP WACC is calculated based on the contribution of each: the debt and the equity.06% 36.998.68% 34.17% 22.51% 36.998. It has to be remembered that there exists circularity and this is the result of iterations done by the spreadsheet. It has to be remembered that there exists circularity and this is the result of iterations done by the spreadsheet.604.073.34% 36.62% 7. the CCF does not have any meaning.985.5 Year 1 45.79 43. 24 .62% 1. and market value of equity calculation with CFE at e Year 0 CFE=FCF+TS-CFD PV(CFE at e) Year 1 4.275.67% 31.13% 38.843. Table A32 APV and market value calculations Year 0 PV(FCF at ρ ) PV(TS at d) Total 45.41% 22.55 67.65% 36.285.41 66.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 48.72 Year 2 5.429.151.64% 29.

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