attempt to estimate the expected cash flows that will be generated by

# Attempt to estimate the expected cash flows that will

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- attempt to estimate the expected cash flows that will be generated by combination - usually include very specific assumptions - period where abnormal growth occurs – the period of time when the company is expected to yield a competitive advantage. - after the competitive advantage is exhausted the constant growth is included in the terminal value calculation 2.) Terminal Value - based on the final cash flow estimated during the forecast period - constant growth assumption and indefinite period of time - perpetual flow of constantly growing cash flows = estimation of the present value of the cash flows generated after the forecast period. NB! When working with calculation of the terminal value – conservative assumptions must be made Since valuation happens over a long period of time – small changes have a profound effect. 2 | P a g e Terminal Value = FCF t x ( 1 + g ) ( WACC – g ) FCF t = the free cash flow during the final year of the forecast period consisting of t years g = the constant growth rate assumed after the forecast period WACC = the company’s weighted cost of capital

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Calculating Free Cash Flow - Step 1 – estimate the expected free cash flow ( amount available to company’s capital providers after provision for investments in fixed and working capital) - During the process of estimating FCF – focus is placed on determining the operating cash flow attributable to the business combination - These calculations include any changes in income and expenses as well as assets due to the combination 3 | P a g e Example ( Page 110 ) Assume that the board of directors of WCB Ltd. is considering other expansion investments , and identified a target company that would enable them to achieve the desired expansion. They approached you to calculate a value for this company, Beta Ltd ., which they could use as an estimate of the fair value of the acquisition. Beta Ltd.’s WACC amounts to 10%. As part of your analysis, you forecasted Beta Ltd.’s free cash flow (FCF) for the next five years, and after Year 5, a constant growth rate of 5% is assumed. Your FCF estimations for the next five years are as follows: Currently Year 1 Year 2 Year 3 Year 4 Year 5 FCF 10 000 12 000 15 000 19 000 22 000 24 000 Step 1 – calculate terminal value FCF 5 x (1 + g) = 24000 x ( 1 + 0.05 ) = R504 000 (WACC- g) ( 0.10 – 0.05 ) Step 2 – calculation of company value CF 1 = 12000 CF 2 = 15000 CF 3 = 19000 CF 4 = 22000 CF 5 = 528000 (24000 + 504000) i = 10% NPV = ?? R380 453.52 FCF = EBIT (1-T) + NCI – CAPEX – ΔNOWC EBIT = earnings before finance costs (interest) and tax T = marginal tax rate NCI = Non-Cash Items , like depreciations, amortisation and impairment of goodwill CAPEX = capital expenditure on fixed assets ΔNOWC = change in the net operating working capital (trade receivables, trade payables, inventory)
4 | P a g e Example (Page 112) Suppose that WCB Ltd. identified another potential target company that is operating in an unrelated industry.

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