You are valuing DistressCo, a company struggling to hold market share. The compa
ID: 2741908 • Letter: Y
Question
You are valuing DistressCo, a company struggling to hold market share. The company currently generates $120 million in revenue, but its revenue is expected to shrink to $100 million next year. Cost of sales currently equals $90 million and depreciation equals $18 million. Working capital equals $36 million and equipment equals $120 million. Using this data, construct operating prot and invested capital for the current year. You decide to build an as-is valuation of DistressCo. To do this, you forecast each ratio (such as cost of sales to revenues) at its current level.
(a) Based on this forecast method, what are operating prots and invested capital expected to be next year?
(b) What are two critical operating assumptions (identify one for prots, and one for capital) embedded in this forecast method?
(c) Assume NOPLAT is expected to grow at 6%, ROIC equals 16%, and the weighted cost of capital is 10%. Using the key driver formula in chapter 2, what is the enterprise value for the company?
PS: I need detailed solution for each part. Plz help me, thx
Explanation / Answer
Calculation of Operating Profit in Current Year:-
Particulars
In Millions of Dollars
Revenue
(-) Cost of Sales
120
90
Gross Profit
(-) Depreciation
30
18
Operating Profit in Current Year
12
a) Operating Profit and Invested Capital expected to be in next year:-
Particulars
In Millions of Dollars
Revenue
(-) Cost of Sales (100 * 90 / 120)
100
75
Gross Profit
(-) Depreciation
25
18
Operating Profit in next Year
7
Invested Capital in next year = 120 + (100 * 36 /120) = 120 + 30 = $ 150 Million
Operating Profit in next Year = $ 7 Million
b) Two critical operating assumptions (identify one for prots, and one for capital) embedded in this forecast method :-
1) Cost of Sales in next year is calculated based on the percentage it bears to the revenue in current year. Assuming this trend remains same in next year i.e., cost of sales is directly proportionate to the revenue amount.
2) Working capital in the next year is calculated based on the percentage it bears to the revenue in current year. Assuming this trend remains same in next year i.e., working capital is directly proportionate to the revenue amount.
c) Enterprise value = [Invested Capital in next year * ROIC * (1 – Growth rate) / ROIC] / (WACC – Growth rate).
Enterprise value = [150 * 0.16 * (1 - 0.06) / 0.16] / (0.10 – 0.06)
Enterprise value = [150 * 0.16 * 5.875] / 0.04
Enterprise value = 141 / 0.04
Enterprise value = $ 3525 Million
Particulars
In Millions of Dollars
Revenue
(-) Cost of Sales
120
90
Gross Profit
(-) Depreciation
30
18
Operating Profit in Current Year
12
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