Paccolin is a start-up company with a cost of equity capital of 10% per annum. It is

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Paccolin is a start-up company with a cost of equity capital of 10% per annum. It is 100% equity financed. Assume for simplicity that it pays no taxes. It is now the end of 2021. It is predicted that Paccolin’s sales revenue will be GBP (£) 400,000 in the year 2022 and that sales growth rates from 2023 to 2027 will be as follows:

Year	2023	2024	2025	2026	2027
Sales growth (%)	50%	40%	25%	10%	4%

Assume that operating expenses always equal 50% of sales; and that, starting at £80,000 in the year 2021, net operating working capital always equals 20% of the following year’s sales.

The carrying amount of net non-current operating assets (in £ ‘000) will be as follows:

End of year

2021

2022

2023

2024

2025

2026

Net non-current

operating assets

2,000

2,100

2,200

2,300

2,400

2,500

a) Calculate Paccolin’s expected free cash flow to equity (FCFE) from 2022 to 2026.

b) Assuming that Paccolin’s free cash flow to equity grows at 4.85% in 2027 and then at 4% in the post-horizon period from 2028 onwards, and given that there are 1 million shares outstanding, calculate the intrinsic value of a share in Paccolin at the end of 2021.

c) Explain under what assumptions one might arrive at a prediction of a long-term FCFE growth rate of 4% for the post-horizon period.

d) What proportion of the value of equity you calculated in part (b) is due to FCFE expected in the post-horizon period? Comment on this. To what extent would this be different if you had used a different valuation method?

e) By how much would the share price you calculated in part (b) change if the assumed post-horizon growth rate (i) increased, or (ii) decreased by 1%? Explain briefly what additional considerations or methods would help you to arrive at a more precise estimate of the value of Paccolin’s equity.

f) Explain the drawbacks of using the dividend discount model or free cash flow-based models when valuing a young company with positive expected net present value (NPV) investment opportunities and heavy investment in operating assets.