632598256894

where EBIT is earnings before interest and taxes, t is the income tax rate, Depreciation is the firm‟s
Depreciation expense, CAPX is the firm‟s capital expenditures, and ΔNWC is the firm‟s change in net
working capital (current assets less current liabilities).
Capital expenditures increase net assets, depreciation expense decreases net assets, and the change
in net working capital changes net assets (NA), so:
Since the firm is growing through time, net assets increase, requiring an investment of cash; thus the
negative sign in front of the growth rate, g. There is less cash flow available for investors, because
cash must be invested in the firm to sustain firm growth. Net assets equal current assets minus current
liabilities plus net property, plant, and equipment, so:
This implies that the terminal value for any firm at time t, with the first constant-growth cash flow
at time t + 1, can be determined with this formula:
where EBIT t+1 equals EBIT in year t times 1 plus the growth rate, g.
This formula tells us that once any firm becomes a growing perpetuity in year t + 1, we can
determine its value in year t once we have its income tax rate, earnings before interest and taxes in
year t, constant growth rate, net assets in year t, and its discount rate. Our forecasts show Hudson
Hybrid Car Company becomes a growing perpetuity in year 2013, so the formula can be applied to
determine the value of the cash flows generated in the years 2013 and beyond, as of the year 2012.
This is the benefit of terminal value; once a company becomes a growing perpetuity we can collapse
the cash flows that are generated during the firm‟s constant and perpetual growth stage with one
calculation.
We will now use the forecasted financial information presented in Exhibit 5.10, Hudson‟s constant
and perpetual growth rate and cost of capital, and this terminal value formula to determine Hudson‟s
total value to all investors. Once we have this figure, we will subtract the amount Hudson owes its
long-term debt holders, and since common equity is a residual, Hudson‟s total value minus the amount
owed long-term debt holders equals the value of Hudson‟s common equity. This result will be
calculated using the stock valuation template included in the chapter materials.
The valuation template begins with Hudson‟s financial results for 2008 and forecasts for 2009
through 2012, as presented in Exhibit 5.10. The first thing that must be done with these data is
calculate Hudson‟s net working capital, change in net working capital, and capital expenditures during
the forecast period. The value of the company is calculated by discounting the cash flow generated by
the company, and increases in working capital and capital expenditures require the investment of cash
and therefore reduce the cash flow available to Hudson‟s investors, both debt and equity investors.
These calculations are performed in the valuation template and are shown in Exhibit 5.11.
These calculations tell us that Hudson will invest $2,656,000 in net working capital, plus
$124,210,000 in capital expenditures during 2009. These calculations are important because the total
investment of $126,866,000 reduces the amount of cash flow available for Hudson‟s investors. These
total investments, combined with the financial forecasts presented in Exhibit 5.10, along with
Hudson‟s constant and perpetual growth rate of 6.5% for the years 2013 and beyond, almost provide