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FIN+4414+-+Free+Cash+Flow+-+Rebalancing+Example

# FIN+4414+-+Free+Cash+Flow+-+Rebalancing+Example - = \$2,500...

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FCF = OCF - NOWC - GFA If depreciation is zero, then FCF = NOPAT - NOWC - NFA Financing: (1) \$1,000 of debt financing at r D = 5%. Creditors require \$50/year. If T=40%, then this will educe taxes by (\$50)(.40) = \$20. The net after- tax cost to the firm is then \$50 - \$20 = \$30, or \$30/\$1,000 = 3%. Alternatively, after-tax cost = (r D )(1-T) = (5%)(1-.4) = 3%. (2) \$1,000 of equity financing at r S = 14%. Stockholders will require \$140/year. Total required by investors = \$30 + \$140 = \$170 WACC = \$170/\$2,000 = 8.5% WACC = (.05)(1-.4)(.5) + (.14)(.5) = 1.5% + 7.0% = 8.5% __________ If NOPAT = \$170, then EBIT = \$170/.6 = \$283.33 EBIT \$ 283.33 Less: Interest -\$ 50.00 EBT \$ 233.33 Less: Taxes - \$ 93.33 Net Income \$140.000 / .14 = \$1,000 = Equity Firm Value = \$170 / .085 = \$2,000 => NPV = \$0 __________ Free Cash Flow – Rebalancing Example Page 1 Year NOPAT NOWC NFA FCF 0 \$0 -\$500 -\$1,500 -\$2000 1 \$170 \$0 \$0 \$170 2 \$170 \$0 \$0 \$170 \$170 \$0 \$0 \$170 \$170 \$0 \$0 \$170

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Suppose NOPAT = \$212.50 Firm Value = \$212.50 / .085
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Unformatted text preview: = \$2,500 => NPV = \$500 (D = \$1,000; S = \$1,500) NOPAT \$ 212.50 Required-\$ 170.00 EVA \$ 42.50 / .085 = \$500 = NPV If NOPAT = \$212.50, then EBIT = \$212.50/.6 = \$354.17 EBIT \$ 354.17 Less: Interest-\$ 50.00 EBT \$ 304.17 Less: Taxes- \$ 121.67 Net Income \$ 182.50 / .14 = \$1,303.57 ≠ Equity Firm Value = \$212.50 / .085 = \$2,500 => NPV = \$500 Debt = \$1,000/\$2,500 = .40; Equity = \$1,500/\$2,500 = .60 WACC = 0.085 = (.03)(.4) + (r S )(.6) => (.085 - .012)/(.6) = .1217 = r S \$182.50 / .1217 = \$1,500 r S has decreased because the debt/equity ratio has decreased and there is less financial risk. __________ Alternatively, could rebalance to 50% debt (\$1,250) and 50% equity (\$1,250) Interest would now be (\$1,250)(.05) = \$62.50 EBIT \$ 354.17 Less: Interest-\$ 62.50 EBT \$ 291.67 Less: Taxes- \$ 116.67 Net Income \$ 175.00 / .14 = \$1,250.00 = Equity Free Cash Flow – Rebalancing Example Page 2...
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FIN+4414+-+Free+Cash+Flow+-+Rebalancing+Example - = \$2,500...

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