Aqua Packaging Corp. makes industrial packaging equipment used primarily by automobile manufacturers to produce protective covering for new luxury automobiles being shipped to dealers across the US by train and by truck. It also makes industrial packaging equipment for other consumer goods companies. Below you will find balance sheets for Aqua as of December 31, 2014 and December 31, 2013 and an income statement for the fiscal year ending December 31, 2014 (“fiscal 2014.”) Both statements have been prepared according to GAAP; amounts shown are in millions of US dollars.
Balance Sheet (for year ending December 31, 2014)
Cash 10.3 Trade payables 91.7
Marketable securities 94.6 Taxes payable 14.5
Accounts receivable 85.7 Current portion, LT debt 35.0
Inventory 112.3
Current assets 302.9 Current liabilities 141.2
Net property, plant and equipment 621.4 Long-term debt 325.0
Investments in subsidiaries 81.3 Deferred tax payable 71.2
Patents, other intangibles 14.2 Shareholders’ equity 482.4
Total assets 1,019.8 Total liabilities and Sh. Equity 1,019.8
Balance Sheet (for year ending December 31, 2013)
Cash 14.7 Trade payables 81.4
Marketable securities 112.6 Taxes payable 1.3
Accounts receivable 78.6 Current portion, LT debt 10.0
Inventory 114.9
Current assets 320.8 Current liabilities 92.7
Net property, plant and equipment 620.0 Long-term debt 360.0
Investments in subsidiaries 81.3 Deferred tax payable 71.2
Patents, other intangibles 14.2 Shareholders’ equity 512.4
Total assets 1,036.3 Total liabilities and Sh. Equity 1,036.3
Income Statement
Revenues 924.2
Cost of goods sold 691.5
Other operating expenses 171.4
EBIT 61.3
Interest income 3.6
Interest expense 19.5
EBT 45.4
Income taxes 14.1
Net income 31.3
Other data:
Depreciation expense included in 2014 income was $6.7 million. Capital expenditures in fiscal 2014 were $8.1 million, and Aqua paid dividends of $61.3 million in that year.
Aqua’s debt consists of 2 bond issues: $75 million with a coupon of 7% (maturing in 2025) and $250 million with a coupon of 5% (maturing in 2030.). Aqua would pay a coupon of 8.5% on a bond issue today.
For forecasting, assume Aqua pays a tax rate of 34% on EBIT.
In today’s market, investors can earn a 4% rate of return on a short-term US Treasury note and 6% on a long-term US Treasury bond. Last year, the S&P 500 earned a rate of return of 14.5%.
Aqua’s stock is deemed to have a BETA of 1.1, and you would require a 7% risk premium for an investment in the market portfolio.
The macroeconomic outlook for the packaging equipment industry: the industry grows revenues in line with US GDP, which is expected to grow (on average) 3.5% over the next 7 years. You believe there is a 100% probability of a recession during that period; industry revenues typically drop 10% in a recessionary year.
Cost structure of Aqua: COGS in fiscal 2014 was 46% fixed and 54% variable. Other operating expenses were 34% fixed and 66% variable. For your forecast, assume that fixed costs remain constant for the entire forecast period. Also assume that variable costs remain at the same ratio to revenues as in fiscal 2014. Capital expenditures are forecast at $7.5 million for fiscal 2015, growing at 3% per annum thereafter.
YOUR ASSIGNMENT:
1. Produce a cash flow statement for Aqua for the fiscal year 2014.
2. Determine Free Cash Flow (FCF) for Aqua in fiscal 2014.
3. Produce a 7-year forecast of revenue for Aqua, beginning with fiscal year 2015 (which began January 1, 2015). Explain the details of your forecast.
4. Produce a 7-year forecast of COGS and other operating expenses.
5. Assume that the forecasts in #3 and #4 above are CASH revenues and expenses; produce a 7-year forecast of Free Cash Flow for Aqua.
6. Determine an appropriate horizon (terminal) value for Aqua’s FCF; use a constant growth rate of 2%.
7. What is your estimate of Enterprise Value for Aqua as of January 1, 2015?
8. What is your estimate of the value of Aqua’s equity capital as of the same date?
9. Identify THREE key drivers of Enterprise Value for Aqua; explain why these three are critical to determination of Aqua’s Enterprise Value.
10. Prepare sensitivity analysis on each of the 3 key drivers that you chose in #9.
Question
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Answer 9 & 10: Enterprise value determinants and sensitivity analysisThe enterprise value of the company is the sum of the market values of debt and equity. The value has been determined by discounting the future value of the expected cash inflows to be generated by the firm. In this case, the two-stage period has been used in which a different growth rate of 3.5% has been applied to discount the cash flows over the initial 7 year period 2015-2021. After the end of this stage, it is expected that the cash flows would grow at the perpetual rate of 2% in the future.
The biggest component of the enterprise value is the terminal value of the firm. Its magnitude is the largest compared to the cash flows expected over 7 years since it represents the present value of all the future cash flows in a perpetual manner. As such, if the terminal value would change, the value of the company would also change drastically. The determinants of terminal value are the discount rate, the expected long-term growth rate and the free cash flow of the firm expected in year 2021. Due to the large magnitude of the terminal value, it can be concluded that the business is most susceptible to the changes in this value. Therefore, it can be concluded that the three major determinants of the enterprise value are:
1. Weighted average cost of capital or the discount rate
2. Long term growth rate of the company
3. Free cash flow in the year from where company is expected to grow perpetually....
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