Reeby Sports

Corporate Finance Case 1

To calculate the present value of future cash flow in 2013, we first calculate the free cash flow between 2014-2020:

Table 1: Free cash flow of 2014-2020 (in $million)

2014 2015 2016 2017 2018 2019 2020

After-tax profits 5.25 5.70 3.00 3.40 4.35 6.00 7.60

Depreciation 2.40 3.10 3.12 3.17 3.26 3.44 3.68

Gross investment in fixed assets (4.26) (10.50) (3.34) (3.65) (4.18) (5.37) (6.28)

Investment in net working capital (1.39) (0.60) (0.28) (0.42) (0.93) (1.57) (2.00)

Free cash flow 2.00 -2.30 2.50 2.50 2.50 2.50 3.00

Discount these cash flow into 2013 at 10%:

PV_(cash flow)=8.01

Then we calculated the horizon value of 2020, of which there are two types of calculation:

Suppose Reeby Sports will lose in the market competition and has no PVGO, then its 2020 horizon value will equal to:

PV_H= 7.60/0.10=76.00

In this way, the present value of 2013 will be:

PV_2013= 8.01+76.00/〖(1+0.10)〗^7 =47.00

Suppose Reeby Sports will still win in its market competition in 2020, then its 2020 horizon value will equal to its free cash flow of 2021 over cost of capital minus growth rate.

To calculate its free cash flow of 2021, we first calculate the book value of equity of Reeby Sports:

Table 2: Book value of equity of 2014-2021 (in $million)

2014 2015 2016 2017 2018 2019 2020 2021

Book value of equity at the beginning of the year 40.71 43.96 51.96 52.46 53.36 55.21 58.71 63.31

Gross investment in fixed assets 4.26 10.50 3.34 3.65 4.18 5.37 6.28

Investment in net working capital 1.39 0.60 0.28 0.42 0.93 1.57 2.00

Depreciation (2.40) (3.10) (3.12) (3.17) (3.26) (3.44) (3.68)

Book value of equity at the end of the year 43.96 51.96 52.46 53.36 55.21 58.71 63.31

With the book value of equity of 2021, we can calculate its net income:

Net income=Equity×ROE=63.31×0.12=7.60

Retained profits=7.60×0.60=4.56

then we can notice that:

Net capital spending+Change in NWC=Retained...