Financial information for GoGear Stores is given below. It is the end of 2019. Management

expects sales to increase 15 percent in 2020 and 10 percent in 2021; after then, sales growth is

expected to slow down to 4% a year, into the indefinite future. Management also believes the gross

profit margin will improve permanently to 50% by next year. Meanwhile, selling and administrative

costs are expected to rise by 10% in each of the next two years, after which they will remain at the

ratio-to-sales reached in 2021. The company's effective tax rate is expected to be 35 percent.

GoGear Stores currently has $6 million of net working capital (which includes the cash needed to run

the business). In future, management expects net working capital to be about 20% of sales.

Net fixed assets at year end 2019 are $18 million. Management expects to invest $6 million during

2020 and another $3 million in 2021 in plant and equipment to enable the firm to meet sales

projections (these expenditures cover both the amounts need to replace depreciated assets and provide

additional capacity). These investments will increase annual depreciation to $2.04m in 2020 and to

$2.22m in 2021. After 2021, net fixed asset turnover will stabilize at 1.5, and depreciation will be

10% of beginning-of-year net fixed asset.

a.Prepare pro forma income statements for 2020-2022 (for simplicity, assume interest expense

remains constant).

b. Calculate (firm) free cash flow for the years 2020-2022.

c. Value GoGear's equity assuming a discount rate of 11% and a total debt at the end of 2019 of

$7.2 million. Compare and contrast GoGear's value under (a) the projected growth

assumptions given above and (b) the value obtained under the assumption that after 2022,

GoGear's market is competitive (that is, PVGO=0).

d. For each of the two valuations obtained in part c. above, find GoGear's market value debt

ratio at the end of 2019, as well as its (trailing) AMV/EBITDA and P/E multiples.1

1 AMV is Adjusted Market Value (or Enterprise Value): the value of the entire firm excluding (excess) cash if any.

e. You have identified industry peers for GoGear Stores, which indicate that it should trade at a

trailing AMV/EBITDA of 9 and P/E of 14. What would these multiples imply about the

value of GoGear's equity today?

f. Suppose you were to use today's peer multiples to obtain a remainder value for the end of

2022. How would your estimate differ from your remainder value estimates obtained in part

c.? What economic factors do you think could explain the difference?

g. Conclude by stating a range of value for GoGear's equity today and explaining why you have

reached this conclusion.

Net Sales $27,000

Cost of goods sold $14,850

Gross margin $12,150

Operating expenses:

Sales and administrative $7,350

Depreciation $1,500

Operating income $3,300

Interest $600

$2,700

Income taxes $675

Net income $2,025