Cash Flow and Net Present Value
Fojtasek financing problem is very common to many other family companies. Family members are not interested in the family business, they would rather liquidate their equity and use it to do something else. Compare with traditional buy-out and leveraged recapitalization, the offer from Heritage seems the best option even though the price is undervalued. The first reason, Heritage Partners is an expert in the market segment of mature but successful family companies. They are aware of the firm’s operating activities, from manufacturing to distribution, to services with customers. Their expertise helps Fojtasek maintain a stable revenue and profit. The most significant concern is that the offer from Heritage Partners helps Fojtasek to avoid the fear of losing control to the firm and a huge interest expense payment from long term debt that is implied by traditional buy-out and leveraged recapitalizations.
Fair market value of the firm:
Rm: Prime rate = 9% rf: risk free rate = 7.2% Average Unleveraged beta bu = = .839
Assume that growth rate : g = 2%, RPm = 4% , tax rate is 35% Unlevered cost of equity rsu = rf + RPm (bu) = 7.2% + 4%(.839) = 10.56%
Operating cash flow using base case projections: 1995 1996 1997 1998 1999
Cash Flow 7,772 9,233 9,807 10,292 10,513
Interest Expenses 3,587 3,042 2,324 1,507 599
Interest * Tax rate 1255.45 1064.7 813.4 527.45 209.65
TV1999 = 10513 + (10513*1.02)/(10.56%-2% ) = $135.81 Million
Vunlevered = Net present value of future operating cash flow = $ 110.9 million.
The firm cost of debt: Rd = 9% + 1.5% = 10.5%
V taxshield= Net present value of interest tax savings = $3 million
Fair market value of the firm = 110.9+ 3 = $113.9 M
Operating cash flow using management case projections: This case yields very high growth rate. Assume growth rate is 6% 1995 1996 1997 1998 1999
Cash Flow 7353 9224 10,724 12,308 13,736
Interest Exp. 3,610 3,091 2,329 1,349 226
Interest * Tax Rate 1263.5 1081.85 815.15 472.15
Fair market value of the firm:
Rm: Prime rate = 9% rf: risk free rate = 7.2% Average Unleveraged beta bu = = .839
Assume that growth rate : g = 2%, RPm = 4% , tax rate is 35% Unlevered cost of equity rsu = rf + RPm (bu) = 7.2% + 4%(.839) = 10.56%
Operating cash flow using base case projections: 1995 1996 1997 1998 1999
Cash Flow 7,772 9,233 9,807 10,292 10,513
Interest Expenses 3,587 3,042 2,324 1,507 599
Interest * Tax rate 1255.45 1064.7 813.4 527.45 209.65
TV1999 = 10513 + (10513*1.02)/(10.56%-2% ) = $135.81 Million
Vunlevered = Net present value of future operating cash flow = $ 110.9 million.
The firm cost of debt: Rd = 9% + 1.5% = 10.5%
V taxshield= Net present value of interest tax savings = $3 million
Fair market value of the firm = 110.9+ 3 = $113.9 M
Operating cash flow using management case projections: This case yields very high growth rate. Assume growth rate is 6% 1995 1996 1997 1998 1999
Cash Flow 7353 9224 10,724 12,308 13,736
Interest Exp. 3,610 3,091 2,329 1,349 226
Interest * Tax Rate 1263.5 1081.85 815.15 472.15