Question

Table 2 Projected Cash Flow Statements (In Millions) Year 1 Year 2 Year 3 Year 4 Year 5 Sales $20 $53 $102 $117 $129 Cost of goods sold 10 26 51 59 65 Gross margin $10 $27 $51 $58 $ 64 General/administrative expenses 5 10 19 23 25 Debt service requirements 5 5 5 5 10 Pre-tax earnings $0 $12 $27 $ 30 $ 29 Taxes 0 5 12 13 14 Net income $0 $7 $ 15 $ 17 $ 15 Depreciation/amortization 2 6 6 6 6 Terminal value 116 Net cash flow $2 $13 $21 $23 $137 Notes: (a) Depreciation/amortization expense is included in the cost of goods sold, yet it is a noncash charge. Thus, it must be added back to net income to obtain the net cash flow in each year. (b) The terminal value is the present value, as of the end of Year 5, of the equity cash flows that are expected to occur after Year 5. This value was obtained by assuming 10 percent annual growth in equity cash flows after Year 5 and a cost of equity of 30 percent: Terminal value = \frac{$21(1.10)}{0.30 - 0.10} = $116.

          Table 2
Projected Cash Flow Statements
(In Millions)
Year 1
Year 2
Year 3
Year 4
Year 5
Sales
$20
$53
$102
$117
$129
Cost of goods sold
10
26
51
59
65
Gross margin
$10
$27
$51
$58
$ 64
General/administrative expenses
5
10
19
23
25
Debt service requirements
5
5
5
5
10
Pre-tax earnings
$0
$12
$27
$ 30
$ 29
Taxes
0
5
12
13
14
Net income
$0
$7
$ 15
$ 17
$ 15
Depreciation/amortization
2
6
6
6
6
Terminal value
116
Net cash flow
$2
$13
$21
$23
$137
Notes: (a)
Depreciation/amortization expense is included in the cost of goods sold, yet it is
a noncash charge. Thus, it must be added back to net income to obtain the net
cash flow in each year.
(b)
The terminal value is the present value, as of the end of Year 5, of the equity
cash flows that are expected to occur after Year 5. This value was obtained by
assuming 10 percent annual growth in equity cash flows after Year 5 and a cost
of equity of 30 percent:
Terminal value = \frac{$21(1.10)}{0.30 - 0.10} = $116.

$Table 2 Projected Cash Flow Statements (In Millions) Year 1 Year 2 Year 3 Year 4 Year 5 Sales $20 $53 $102 $117 $129 Cost of goods sold 10 26 51 59 65 Gross margin $10 $27 $51 $58 $ 64 General/administrative expenses 5 10 19 23 25 Debt service requirements 5 5 5 5 10 Pre-tax earnings $0 $12 $27 $ 30 $ 29 Taxes 0 5 12 13 14 Net income $0 $7 $ 15 $ 17 $ 15 Depreciation/amortization 2 6 6 6 6 Terminal value 116 Net cash flow $2 $13 $21 $23 $137 Notes: (a) Depreciation/amortization expense is included in the cost of goods sold, yet it is a noncash charge. Thus, it must be added back to net income to obtain the net cash flow in each year. (b) The terminal value is the present value, as of the end of Year 5, of the equity cash flows that are expected to occur after Year 5. This value was obtained by assuming 10 percent annual growth in equity cash flows after Year 5 and a cost of equity of 30 percent: Terminal value = \frac{$21(1.10)}{0.30 - 0.10} = $116.$

Added by Adam G.

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