A Valuation Exercise Using the FCF Approach - Teton Valley Corporation

A Valuation Exercise Using the FCF Approach - Teton Valley Corporation:

You have been hired to value the Teton Valley Corporation (TVC) of Driggs, Idaho. TVC manufactures outdoor equipment, specifically tents, backpacks, gaitors, and headgear. TVC’s “signature product” is its world-famous extreme weather tent line, the WhiteOut Expedition, often used in expeditions up Chomolungma (Mount Everest), K2, and Denali. You just completed your WACC calculation for TVC and came up with a 16% rate.

While publicly held, TVC’s shares trade only intermittently on the Spokane Stock Exchange. Approximately 30% of the firm is held by the family of the founders. Because of the lack of a ready market and trading activity, you have established that a 20% liquidity discount is appropriate. 1,000,000 shares are currently outstanding.

TVC has an Employee Stock Option Plan (ESOP) and is required to perform an annual stock valuation to determine the allowable contribution deduction for tax purposes.

The firm’s current book-value balance sheet is simplified as follows:

1 TETON VALLEY CORPORATION December 31, 2006

Current Assets $250,000 Non-Interest Bearing Liabilities $170,000 Net Fixed Assets $750,000 Aggregate Interest-Bearing Debt $350,000 Equity $480,000 Total Assets $1,000,000 Total Liabilities + Equity $1,000,000

The firm’s most recent simplified income statement for 2006 is as follows:

TETON VALLEY CORPORATION Twelve Months Ending December 31, 2006

Sales $5,500,000 Cost of Goods Sold 3,575,000 Gross Margin $1,925,000 GS&A 747,500 Depreciation 140,000 EBIT $1,037,500 Interest 42,000 EBT $ 995,500 Tax (0.30) 298,650 EAT $ 696,850

TVC management has forecast its sales growth to be 10% for the next five years. At that point, they expect sales to grow at the GDP growth rate, or about 4% per year into perpetuity.

TVC’s cost of goods sold runs a reliable 65% of sales. GS&A expenses have a fixed component of $500,000, plus a variable component of 4.5% of sales.

Net fixed assets are expected to grow at 5% per year for the next five years from the current level B capital expenditures less depreciation expense. Depreciation expense is expected to run at 20% of beginning net fixed assets.

Net working capital, current assets less current liabilities, is currently $80,000 and is expected to grow at the same rate as sales for the next five years.

After year 5, or 2011, free cash flows are expected to grow at 4% in perpetuity, relative to the 2011 level.

How would you develop a forecast of Free Cash Flows for TVC covering the foreseeable future?

Later we will ask: What is the total market value of TVC? What is its total equity and per share value?

The current rate on 20 year government bonds is 6% and the market risk premium is estimated at 7.45%. The firm has a target debt to value ratio of 4%, can borrow at 1.0% above government rates due to their high bond rating, and currently has an equity beta of 1.4. How do you feel about your estimate of WACC?

What other valuation methods would you employ as robustness checks?