ABC Companys CFO has provided a long-term forecast for ABC as follows:

EBIT Net Income Discount Factor

2020 $42,000,000 $20,000,000 0.91

2021 $44,000,000 $21,000,000 0.83

2022 $46,000,000 $22,000,000 0.75

2023 $48,000,000 $23,000,000 0.68

2024 $50,000,000 $24,000,000 0.62

Assumptions:

• The growth rate after 2024 is 3%
• XYZ Company uses a 10% weighted average cost of capital (WACC) and a minimum required return on equity of 13.33%
• The tax rate is 50%
• The company pays $2,000,000 a year in interest for all years
• Depreciation is expected to be $5,000,000 per year
  • After 2020, new equipment purchases are expected to be $10,000,000 a year
  • After 2020, net cash outflow of these two items is ($5,000,000) a year
  • See expenditures for 2020 above which is a one-time modernization year
• Net working capital changes are assumed to be ($1,000,000) a year as sales grow
• The terminal value of the company at the end of 2024 is $280,000,000
• The purchase will take place at the beginning of 2020, if accepted

Required:

1. Prepare a valuation of ABC Companys common shares using the free cash flow to the firm method and subtracting debt. (10 marks)
2. What is the EBITDA based intrinsic value of ABC Company using 2020 data. Subtract debt to obtain the intrinsic value of the shares. (4 marks)
3. What are three (3) assumptions in the valuation calculation you would advise XYZ Companys CFO to keep in mind in assessing the sensitivity of results of the valuation. (3 marks)
4. Do you think the company is a buy, yes or no? Is goodwill a factor in the decision? Given reasons for your answers. (3 marks)