The JMR Company is a family business that currently uses no debt in its capital structure....

 

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The JMR Company is a family business that currently uses no debt in its capital structure. The owner-managers agreed on a plan to issue a large amount of debt to expand the company's operations. Their plan is to finance the entire transaction by borrowing $15 million of bank loan at an interest rate of 9%, and the debt repayment schedule is fixed. The company also plans on a recapitalization to reach a target capital structure of 20% debt at the end of Year 3. The company's chief financial officer prepared a set of financial forecasts that reflects this plan. The income statement, balance sheet, and cash flow statement forecasts are included in the tables as shown on the next page. The forecasts assume the company will issue the debt at the end of year 0, which is reflected in the balance sheet for that year. The forecasts do not, however, reflect the debt recapitalization at the end of Year 3. The company is expected to enter the constant growth stage starting Year 4 and grow at the long-run inflation rate of 2%. The debt cost of capital will not change while the company is paying off its debt, but it will decrease to 7% when they recapitalize the company to 20% debt at the end of Year 3. Its cost of equity is 15% and the unlevered cost of capital is 10%. The company's income tax rate for all revenues and expenses is 40%. Apply the appropriate valuation model to estimate the intrinsic value of JMR and intrinsic value of equity in year 0. Actual Actual Forecast Forecast Forecast Forecast Year -1 Year 0 Year 1 Year 2 Year 3 Year 4 ($ in thousands) Income Statement $14,823 -5,929 $ 8,765 $15,194 $14,462 -5,785 $13,147 $ 7,968 -3,187 -1,000 Revenue. -6,078 -5,259 -1,875 -3,506 Operating expenses. Depreciation expense. -1,273 -2,226 -2,494 -2,557 $ 6,451 $ 6,560 $ 6,014 -1,500 $ 6,400 -1,320 $ 3,781 $ 3,986 Earnings before interest and taxes. Interest expense.... -1,440 -1,190 $ 3,781 $ 3,986 $ 4,514 $ 5,011 $ 5,080 $ 5,370 Income before taxes. -1,512 -1,594 -1,805 -2,004 -2,032 -2,148 Income tax expense. $ 2,268 $ 2,392 $ 2,708 $ 3,006 $ 3,048 $ 3,222 Net income... Balance Sheet 24 145 2$ 148 2$ 152 $ 1,972 Cash.. 24 80 2$ 88 131 1,514 1,665 2,169 2,224 2,279 Net operating working capital Property, plant & equipment (net). 11,686 16,434 18,077 18,529 18,993 19,467 $13,280 $18,187 $20,181 $20,843 $21,364 $21,898 Total assets.. $ $15,000 $14,400 $13,200 $11,900 $12,198 Debt 13,280 3,187 5,781 7,643 9,464 9,701 Equity. $13,280 $18,187 $20,181 $20,843 $21,364 $21,898 Total liabilities and equities. Cash Flow Statement Cash flows from operations $ 2,708 $ 3,006 $ 3,048 $ 3,222 $ 2,392 1,273 Net income. 1,875 2,226 2,494 2,557 + Depreciation expense - Change in net operating working capital. Cash flow from operations. -151 -307 -197 -54 -56 $ 3,513 $ 4,276 $ 5,036 $ 5,488 $ 5,723 Balance Sheet 2$ 80 24 88 24 131 2$ 145 2$ 148 2$ 152 Cash... 2,279 19,467 1,972 2,169 2,224 1,665 16,434 1,514 Net operating working capital Property, plant & equipment (net). 11,686 18,077 18,529 18,993 $13,280 $18,187 $20,181 $20,843 $21,364 $21,898 Total assets. $14,400 $13,200 $11,900 $12,198 $15,000 3,187 Debt 24 13,280 5,781 7,643 9,464 9,701 Equity $13,280 $18,187 $20,181 $20,843 $21,364 $21,898 Total liabilities and equities. Cash Flow Statement Cash flows from operations Net income.. $ 3,222 2,557 $ 3,006 $ 3,048 2,494 $ 2,708 $ 2,392 1,273 1,875 2,226 + Depreciation expense - Change in net operating working capital. -151 -307 -197 -54 -56 $ 3,513 $ 4,276 $ 5,036 $ 5,488 $ 5,723 Cash flow from operations.. Investing activities $-6,020 $-3,518 $-2,678 $-2,958 $-3,031 Capital expenditures Financing activities + Change in debt financing + Change in common equity financing - Common equity dividends paid. $15,000 $ -600 $-1,200 $-1,300 24 297 -12,485 -114 -1,144 -1,227 -2,985 $ 2,515 $ -714 $-2,344 $-2,527 $-2,688 Cash flows from financing activities. 2$ 8 2$ 44 2$ 13 2$ 24 4 Change in cash balance. Exhibit may contain small rounding errors The JMR Company is a family business that currently uses no debt in its capital structure. The owner-managers agreed on a plan to issue a large amount of debt to expand the company's operations. Their plan is to finance the entire transaction by borrowing $15 million of bank loan at an interest rate of 9%, and the debt repayment schedule is fixed. The company also plans on a recapitalization to reach a target capital structure of 20% debt at the end of Year 3. The company's chief financial officer prepared a set of financial forecasts that reflects this plan. The income statement, balance sheet, and cash flow statement forecasts are included in the tables as shown on the next page. The forecasts assume the company will issue the debt at the end of year 0, which is reflected in the balance sheet for that year. The forecasts do not, however, reflect the debt recapitalization at the end of Year 3. The company is expected to enter the constant growth stage starting Year 4 and grow at the long-run inflation rate of 2%. The debt cost of capital will not change while the company is paying off its debt, but it will decrease to 7% when they recapitalize the company to 20% debt at the end of Year 3. Its cost of equity is 15% and the unlevered cost of capital is 10%. The company's income tax rate for all revenues and expenses is 40%. Apply the appropriate valuation model to estimate the intrinsic value of JMR and intrinsic value of equity in year 0. Actual Actual Forecast Forecast Forecast Forecast Year -1 Year 0 Year 1 Year 2 Year 3 Year 4 ($ in thousands) Income Statement $14,823 -5,929 $ 8,765 $15,194 $14,462 -5,785 $13,147 $ 7,968 -3,187 -1,000 Revenue. -6,078 -5,259 -1,875 -3,506 Operating expenses. Depreciation expense. -1,273 -2,226 -2,494 -2,557 $ 6,451 $ 6,560 $ 6,014 -1,500 $ 6,400 -1,320 $ 3,781 $ 3,986 Earnings before interest and taxes. Interest expense.... -1,440 -1,190 $ 3,781 $ 3,986 $ 4,514 $ 5,011 $ 5,080 $ 5,370 Income before taxes. -1,512 -1,594 -1,805 -2,004 -2,032 -2,148 Income tax expense. $ 2,268 $ 2,392 $ 2,708 $ 3,006 $ 3,048 $ 3,222 Net income... Balance Sheet 24 145 2$ 148 2$ 152 $ 1,972 Cash.. 24 80 2$ 88 131 1,514 1,665 2,169 2,224 2,279 Net operating working capital Property, plant & equipment (net). 11,686 16,434 18,077 18,529 18,993 19,467 $13,280 $18,187 $20,181 $20,843 $21,364 $21,898 Total assets.. $ $15,000 $14,400 $13,200 $11,900 $12,198 Debt 13,280 3,187 5,781 7,643 9,464 9,701 Equity. $13,280 $18,187 $20,181 $20,843 $21,364 $21,898 Total liabilities and equities. Cash Flow Statement Cash flows from operations $ 2,708 $ 3,006 $ 3,048 $ 3,222 $ 2,392 1,273 Net income. 1,875 2,226 2,494 2,557 + Depreciation expense - Change in net operating working capital. Cash flow from operations. -151 -307 -197 -54 -56 $ 3,513 $ 4,276 $ 5,036 $ 5,488 $ 5,723 Balance Sheet 2$ 80 24 88 24 131 2$ 145 2$ 148 2$ 152 Cash... 2,279 19,467 1,972 2,169 2,224 1,665 16,434 1,514 Net operating working capital Property, plant & equipment (net). 11,686 18,077 18,529 18,993 $13,280 $18,187 $20,181 $20,843 $21,364 $21,898 Total assets. $14,400 $13,200 $11,900 $12,198 $15,000 3,187 Debt 24 13,280 5,781 7,643 9,464 9,701 Equity $13,280 $18,187 $20,181 $20,843 $21,364 $21,898 Total liabilities and equities. Cash Flow Statement Cash flows from operations Net income.. $ 3,222 2,557 $ 3,006 $ 3,048 2,494 $ 2,708 $ 2,392 1,273 1,875 2,226 + Depreciation expense - Change in net operating working capital. -151 -307 -197 -54 -56 $ 3,513 $ 4,276 $ 5,036 $ 5,488 $ 5,723 Cash flow from operations.. Investing activities $-6,020 $-3,518 $-2,678 $-2,958 $-3,031 Capital expenditures Financing activities + Change in debt financing + Change in common equity financing - Common equity dividends paid. $15,000 $ -600 $-1,200 $-1,300 24 297 -12,485 -114 -1,144 -1,227 -2,985 $ 2,515 $ -714 $-2,344 $-2,527 $-2,688 Cash flows from financing activities. 2$ 8 2$ 44 2$ 13 2$ 24 4 Change in cash balance. Exhibit may contain small rounding errors