Handout Problem 3 Nostalgia Inc. is a small, privately owned firm that sells antique furnishings. In the most recent year, the firm generated $ 1.5 million in after-tax operating income on revenues of $ 10 million; the firm reported book value of equity of $ 5 million and book value of debt of $2.5 million at the beginning of the year. During the year, the firm invested $ 1 million in a new warehouse for furniture and reported depreciation of $400,000 in its income statement. The firm's only working capital item is its inventory, which increased by $150,000 during the course of the year. You have been asked by the owner to appraise the value of the company for sale and collected the following information on publicly traded counterparts: Publicly traded furniture companies have an average levered beta of 1.15 and an average market debt to equity ratio of 25%. The pre-tax cost of borrowing, on average, at these firms is 7%. The marginal tax rate for both private and publicly traded firms is 40%. On average, the correlation between furniture firms and the market is 0.40. The treasury bond rate is 5% and the equity risk premium is 4%. a. Estimate the free cash flow to the firm to Nostalgia in the most recent year. b. Assuming that the firm maintains its existing return on capital and reinvestment rate for the next 5 years, estimate the expected annual growth rate for that period. c. If you were valuing this company for a sale in a private transaction (to an undiversified individual), what cost of capital would you use for the firm? (You can assume that this firm operates at the industry average debt to equity ratio and shares the same cost of debt) Handout Problem 3 Nostalgia Inc. is a small, privately owned firm that sells antique furnishings. In the most recent year, the firm generated $ 1.5 million in after-tax operating income on revenues of $ 10 million; the firm reported book value of equity of $ 5 million and book value of debt of $2.5 million at the beginning of the year. During the year, the firm invested $ 1 million in a new warehouse for furniture and reported depreciation of $400,000 in its income statement. The firm's only working capital item is its inventory, which increased by $150,000 during the course of the year. You have been asked by the owner to appraise the value of the company for sale and collected the following information on publicly traded counterparts: Publicly traded furniture companies have an average levered beta of 1.15 and an average market debt to equity ratio of 25%. The pre-tax cost of borrowing, on average, at these firms is 7%. The marginal tax rate for both private and publicly traded firms is 40%. On average, the correlation between furniture firms and the market is 0.40. The treasury bond rate is 5% and the equity risk premium is 4%. a. Estimate the free cash flow to the firm to Nostalgia in the most recent year. b. Assuming that the firm maintains its existing return on capital and reinvestment rate for the next 5 years, estimate the expected annual growth rate for that period. c. If you were valuing this company for a sale in a private transaction (to an undiversified individual), what cost of capital would you use for the firm? (You can assume that this firm operates at the industry average debt to equity ratio and shares the same cost of debt)