Following is a free cash flow forecast for Egon’s Paranormal Investigations Corp
ID: 2777284 • Letter: F
Question
Following is a free cash flow forecast for Egon’s Paranormal Investigations Corporation. Use this information for problems following.
($ millions) 2002 2003 2004 2005
NOPAT 20.0 22.0 25.0 28.0
Free cash flow (2.0) 15.0 10.0 20.0
1.You expect NOPAT to grow at 3% per year and for free cash flow to be equal to NOPAT, beginning in 2006. The book value of Egon’s core operations at December 31, 2001 is $100 million and its weighted-average cost of capital is 9%.
a.Forecast Egon’s book value of core operations for 2002–2006.
b.Forecast Egon’s residual income for 2002–2006.
c.Calculate the value of Egon’s core operations as of December 31, 2001, using the residual income method.
2.Confirm your answer to problem 1(c) by taking the present value of Egon’s forecasted free cash flows.3.Redo problem 1 assuming the book value of Egon’s core operations at December 31, 2001 is only $80 million.
Explanation / Answer
Residual Value or Economic value added equals NOPAT minus cost of invested capital. 1 Book value = Opening Book Value + Net earnings - Equity Charge/Dividend In $ Million Years 2002 2003 2004 2005 2006 Equity 100.00 111.00 123.01 136.94 152.61 NOPAT 20.00 22.00 25.00 28.00 28.84 Equity Charge 9% X Equity 9.00 9.99 11.07 12.32 13.74 Residual Income 11.00 12.01 13.93 15.68 15.10 2 Residual Income /EVA = NOPAT - EQUITY CHARGE In $ Million Years 2002 2003 2004 2005 2006 NOPAT 20.00 22.00 25.00 28.00 28.84 Equity Charge 9% X Equity 9.00 9.99 11.07 12.32 13.74 Residual Income 11.00 12.01 13.93 15.68 15.10 3 Recalculation assuming book value of core operations is $80 m Book Value Calculation In $ Million Years 2002 2003 2004 2005 2006 Equity 80.00 92.80 106.45 121.87 138.90 NOPAT 20.00 22.00 25.00 28.00 28.84 Equity Charge 9% X Equity 7.20 8.35 9.58 10.97 12.50 Residual Income 12.80 13.65 15.42 17.03 16.34