Joyces Juice - Valuation

This portion of this case is a relatively simple business valuation that should
reinforce your understanding of the following topics:
Business cash flows
WACC valuation
Introduction
Joyce Smith is contemplating opening a juice stand. Her business plan suggests
that the initial capital investment (i.e., investment in property, plant, and
equipment) will be $450,000. She anticipates capital expenditures of 10% of that
initial value in year 1 and then growing at 3% thereafter. The assets will
depreciate at $50,000 in year 1, $55,000 in year 2, and depreciation will grow at
3% thereafter.
Her juice will initially sell for $1.25 per bottle and will cost $0.40 on average to
produce the 1st year. She anticipates fixed operating costs (excluding depreciation)
of $20,000 in the first year, and $30,000 for the 2nd year and thereafter.
She also expects to sell 100,000 bottles in year 1; 125,000 bottles in year 2; then
150,000 per year in perpetuity.
Joyce expects that prices and costs (variable and fixed) will grow at the estimated
3% rate of inflation in perpetuity after the given projections.
Juice stands typically require net working capital in the amount of 25% of revenues
and Joyce expects this figure to apply to her business. (To be clear, net working
capital balances at the beginning of any given year are 25% of the anticipated
revenues for the rest of that year.) Being in Illinois, Joyce faces a combined
federal and state corporate income tax rate of 40%.

Un-levered Cash flows (No leverage; spreadsheet answer)

1. Construct five-year pro forma income statements for Joyce's unlevered
business.
2. Calculate projections for cash flow from operations, cash flow from
investment in working capital, and un-levered free cash flows for years 0
through 5.
3. Using your cash flow and cost of capital estimates, calculate the NPV (net
present value), Enterprise Value and Market Value of Equity of Joyce's
Business.
4. Create an accounting balance sheet for this company as it would appear
today if funding is received. Place all working capital needs on asset side as
a simplification. What does this indicate is Joyces equity contribution
initially for the company?

With Leverage (spreadsheet answer)

Now assume that Joyce partially funds her initial capital investment by securing
$300,000 of debt at an annual interest rate of 8.0%. Assume that Joyce will roll
over the debt when it matures, so that the $300,000 of debt is outstanding in
perpetuity.
5. Construct five-year pro forma income statements for Joyce's levered
business.
6. Calculate the projected interest coverage ratio (or times interest earned) in
each of the five years. Calculate the interest coverage ratio as (EBIT +
depreciation expense)/ (interest expense). Is this a good coverage ratio?
7. How does Joyces tax bill change in each of the five years because of
leverage?

8. What is the present value of the debt tax shield associated with the $300,000
of debt in perpetuity? (Spreadsheet answer accompanied by a short essay to
explain how you arrived at the discount rate for the debt-tax-shield cashflows.)
9. The city of St. Cloud offers Joyce a temporary elimination of the $10,000
per year in property taxes that she would otherwise have been paying. This
abatement will last for five years. Assume that if Joyce sells the stand, this tax
abatement will be passed on to the new owner. Also assume that property taxes
are a tax-deductible expense. (Note that these property taxes are included in the
fixed operating costs, which are projected to be $20,000 in the first year; ignore
that this would change the long-term growth rate if deducted.) How does this
subsidy affect the value of Joyces business? (Spreadsheet answer accompanied
by a short essay to explain how you arrived at the discount rate for the propertytax-abatement cash flows.)
10. Given your answers to 4-8 what is the Adjusted Present Value (APV),
Enterprise Value and Market Value of Equity for Joyces Juice?
11. Create an accounting balance sheet for this company as it would appear
today if funding is received under the levered scenario. Place all working
capital needs on asset side as a simplification. What does this indicate is
Joyces equity contribution initially for the company?
12. How would a market value balance sheet be different than the book value
balance sheet you created? A market value balance sheet uses PV of future
cash flows for the overall value.