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Chapter 20

Question 7

DCF valuation

The following information has been taken from the statement of profit or loss
and the statement of financial position for X Co:

Revenue: $900k

Production expenses: $375k

Administrative expenses: $290k

Tax-allowable depreciation: $35k

Capital investment in year: $80k

Corporate debt: $100k

Corporation tax is 30%, the WACC is 16.5% and inflation is 4%.

These cash flows are expected to continue for the foreseeable future.

Calculate the value of equity.

Operating profits = $900k – $375k – $290k = $235k

Tax on operating profits = $235k × 0.3 = $70.5k

Tax relief on tax-allowable depreciation: $35k × 0.3 = $10.5k

Free cash flow = $235k – $70.5k + $10.5k – $80k = $95k

Using the real method for discounting (don’t inflate the cash flows and use the
real discount rate):

The cash flows will be a perpetuity of $95k

The real discount rate will be (1.165/1.04) – 1 = 0.12 or 12%

PV of perpetuity = $95k × 1/0.12 = $792k

This values the entire cash flows of the business. To obtain the value of equity
alone, we must deduct the debt value.

Value of equity = $792k – $100k = $692k

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