Page 42 - FINAL CFA II SLIDES JUNE 2019 DAY 7

EXAMPLE: Two-stage FCFE model with declining growth in READING 30: FREE CASH FLOW VALUATION
stage 1: Consider a rival to the Prentice Paint Company
presented in the previous example. Suppose that Sioux Falls
Decor also has revenues of $20 million this year. MODULE 30.5: FCF OTHER ASPECTS

However, we assume that its future performance will be tracked relative to sales as follows:
•Sales growth and the net profit margin are projected by year as shown in the following table:

Let’s demonstrate the calculation of the cash flow
components in Year 1:

Calculate the value of the equity of Sioux Falls using the two-stage FCFE model.

Answer: Recognize that the target debt-to-asset ratio (DR) is 0.40.

Fin calc:
CF 0 = 0; C01 = 0.748; C02 = 0.997; C03 = 1.287; C04 = 1.391; C05 = 30.90I =
12;
CPT → NPV = 20.80

* debt financing = (debt-to-asset ratio) × [(FCInv − Dep) + WCInv]
So for year 3: debt financing = (0.4) × [(1.95) + 0.455] = 0.962