Lessons in Corporate Finance, 2nd Edition

CHAPTER 16Valuation (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 15. We will use the projected cash flows as estimated in Chapter 15. 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 16.1 presents the forecast free cash flows to the firm for Sungreen's Kingsport mill and plant, which we derived in Table 15.8 of Chapter 15.

TABLE 16.1 Sungreen's Pro Forma Free Cash Flows to the Firm Kingsport

($ millions)	2019	2020	2021	2022	2023
Earnings before interest and taxes	34.66	36.96	39.33	41.31	43.37
(1 − Tc)= 1 − 0.21	0.79	0.79	0.79	0.79	0.79
EBIT*(1 − Tc)	27.38	29.19	31.07	32.64	34.26
Plus depreciation	9.38	9.28	9.21	9.17	9.14
Less CAPEX	(5.63)	(6.50)	(7.37)	(8.25)	(9.14)
Less increase in working capital	(1.26)	(1.81)	(1.91)	(1.60)	(1.66)
Free cash flow to the firm	29.87	30.16	31.00	31.96	32.60

As we presented in Chapter 15, the formula for free cash flows to the firm is:

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