Lessons in Corporate Finance

CHAPTER 15 Valuation (Sungreen B)

In the last chapter, we introduced valuation and explained how to value a firm or project by using the discounted cash flow technique and free cash flows to the firm. In this chapter, we will complete the valuation of Sungreen’s Kingsport mill and plant that we started in Chapter 14. We will use the projected cash flows as estimated in Chapter 14. Then we will calculate the cost of capital and terminal value for this project and demonstrate how the projected cash flows, terminal value, and cost of capital are used to value a project or firm. In keeping with our theme of repetition, we will do this in future chapters as well.

Sungreen’s Projected Cash Flows

Table 15.1 presents the forecast free cash flows to the firm for Sungreen’s Kingsport mill and plant, which we derived in Table 14.8 of Chapter 14.

Table 15.1 Pro Forma Free Cash Flows to the Firm

($ millions)	2004	2005	2006	2007	2008
EBIT	37.65	39.97	42.36	44.38	46.43
(1 – Tc) = (1 – 0.35)	0.65	0.65	0.65	0.65	0.65
EBIT * (1 – Tc)	24.47	25.98	27.53	28.85	30.18
Plus depreciation	6.38	6.27	6.18	6.10	6.08
Less CAPEX	(2.01)	(3.00)	(3.00)	(4.99)	(6.08)
Less increase in WC	(1.26)	(1.81)	(1.90)	(1.60)	(1.66)
Free cash flow to firm	27.58	27.44	28.81	28.36	28.52

As we presented in Chapter 14, the formula for free cash flows to the firm is:

FCF_f = EBIT * (1 – T_c) + Dep – CAPEX – (NWC_end – NWC_begin) + Extras

The cash flow formula above is dutifully memorized by most finance ...