Calaveras Vinesyard Case

FIN 457

November 2, 2015

Calaveras Vineyards Case

Dear Dr. Lynna Martinez,

After reviewing your projections of Calaveras Vineyards, I used the adjusted present value method to come up with the value of the company. With this method, I assume that the whole firm is financed only through equity. Therefore, when calculating the free cash flow, debt was not taken into account. Despite that, the net present value of interest shields is added back to compensate the debt in the capital structure. With this method, the company is valued at $9.62 million.

In order to assess Calaveras’ value, I calculated the free cash flow from 1994 to 1998. The free cash flow from each year derived from adding Earnings before Interest and Taxes, Depreciation, and Amortization and subtracting the Change in Net Working Capital, and Capital Expenditure. Earnings before Interest and Taxes were calculated from subtracting tax rate of 37% from Earnings before Interest (EBIT), which was projected in the Income Statement. Other values were based off of the spreadsheet attached with this memo.

Once I got the free cash flow for each year, I used the Cost of Equity or the CAPM rate to discount it to present value. The rate is calculated by adding the risk-free rate with the product of market risk premium and beta. The risk-free rate of 5.85% is based off of the interest rate of 30-year T-bonds. As for the market risk premium, I chose the geometric mean premium of returns on small-company stocks less returns on long-term government bonds, which is 7.4%. I calculated the beta by using the unlevered beta of three comparable companies and their revenue weights. You can see the calculation in details on the spreadsheet.

The present value of the free cash flow is then used to find the total firm value. Other values that are included in the summation are the net present value of interest tax shield, terminal value of free cash flow, and the terminal value of interest tax shield. The net...