Expert answer:Free Cash Flow Analysis
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Assignment-3
Free Cash Flow Analysis (100 points)
Purpose of this Assignment is to forecast and analyze your firm’s FCFF and FCFE. The majority of the
information necessary to compute cash flows comes from either the reported financial statements or
the Value Line report.
A. Set the Time Frame of the Forecast. Be realistic in selecting the detailed analysis time frame. For a
large established company, a 10-year forecast may make sense. You may divide the time frame into
three stages: the immediate future stage (e.g. 5 years), the transitional stage (e.g. 5 years), and the
mature stage (after that).
B. Determine the time period of the detailed forecast for which good estimates are possible and of the
simplified forecast for the more distant future.
C. Perform the detailed forecast for the near future stage, where good estimates are possible. You can
use following formula and make some comments if necessary:
FCFF= EBIT x (1 – TaxRate) + Depreciation – CAPX – Increase in NWC
FCFE = FCFF –Interest x (1-TaxRate) + Increases in net Debt
You can either use the ValueLine approach or the Sale-based approach.
D. Important inputs to discuss/think about:
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Are your margin projections increasing/decreasing/constant?
Is investment in capital expenditures increasing or decreasing?
Is depreciation & amortization increasing or decreasing?
Does the change to Working Capital make sense?
What is your tax rate?
Do not forget to cite your sources where it is necessary.
Do not forget to provide your Excel template.
Problem Solving Assignment (0 points)
1. (15 points) The market consensus is that Analog Electronic Corporation has an ROE = 9% and a
market capitalization rate is 16% per year. It plans to maintain indefinitely its traditional
plowback ratio of 2/3. This year’s earnings were $3 per share. The annual dividend was just paid.
The consensus estimate of the coming year’s market return is 14%, and T-bills currently offer a
6% return.
a. Find the price at which Analog stock should sell.
b. Calculate the leading and trailing P/E ratios.
c. Calculate the PEG ratio.
d. Suppose your research convinces you Analog will announce very soon that it will
immediately reduce its plowback ratio to 1/3. Find the intrinsic value of the stock. If the
market is still unaware of this decision. Explain why V0 no longer equals P0 and why V0 is
greater or less than P0.
2. (10 points) Eagle Products’ EBIT is $300, its tax rate is 35%, depreciation is $20, capital
expenditures are $60, and the planned increase in net working capital is $30. What is the free
cash flow to the firm?
3. (15 points) FinCorp’s free cash flow to the firm is reported as $205 million. The firm’s interest
expense is $22 million. Assume the tax rate is 35% and the net debt of the firm increases by $3
million. What is the market value of equity if the FCFE is projected to grow at 3% indefinitely and
the cost of equity is 12%?
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