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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.

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Answer 9 & 10: Enterprise value determinants and sensitivity analysis
The 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....
Enterprise Valuation - Aqua Packaging Corp.
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