Take-home assignment #2:
Pro forma statements and company valuation
Joe's Coffee Co. is considering a capacity expansion in 2019 to meet the growing demand for its coffee products. If the company undertakes the project, the improved production capacity will help increase the company’s market share from the current 2018 share of 10% by 1% each year in 2019, 2020, and again in 2021. If the company decides not to expand its capacity, then its market share will grow only by 0.5% each year for the same three-year period. The project, should the company take it, will increase its capital expenditures by $40 million in 2019. To finance the project, the company plans to raise $40 million in 2019 through a long-term bank loan at 10% annual interest. Additionally, the company’s management makes the following assumptions for each scenario:
Your goal is to analyze whether or not the project adds value to your company. Your analysis consists of six parts. First, prepare pro forma income statements and balance sheets for year 2019, 2020, and 2021 under each scenario based on the assumptions listed above. Second, estimate annual free cash flow for each of the three years using the following formula:
Annual Free Cash Flow = EBIT x (1-tax rate) + Depreciation – Capital expenditures – Changes in Working capital
Third, estimate the company’s continuation value (also known as terminal value) beyond 2021 by using the Enterprise value / EBITDA multiple I explained in class.
Forth, with your annual cash flows and continuation value forecast, estimate the company’s long-term value by computing the company’s net present value under each scenario. Use 16% as the discount rate.
Fifth, once you have estimated the net present values, determine whether or not the project would increase the company’s long term value by subtracting “No expansion” NPV from “Expansion” NPV.
Sixth, determine how the NPV under each scenario would change as the Market size growth rate varies from -2% to 5% with 0.5% increments using the “What-If” analysis tool in Excel. Read the instruction in “Excel What If analysis.docx” available on Laulima under “Class handouts” to learn how to use the tool.
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