ExpertMedium2 marksShort Answer
ACCA · Question 17.1 · Business Valuations
CASE 2: AERODRONE TECH
AeroDrone Tech is an ungeared manufacturer of commercial delivery drones. The company currently has a cost of equity of 12%. The board is considering a major restructuring to issue debt and repurchase equity. The corporate tax rate is 25%. The risk-free rate is 4% and the equity risk premium is 6%.
AeroDrone's latest financial statements show Operating Profit (EBIT) of $5,000,000. Depreciation was $800,000. Capital expenditure was $1,200,000 and the working capital requirement increased by $300,000.
Calculate AeroDrone Tech's Free Cash Flow to the Firm (FCFF).
(Enter your answer as a whole number without dollar signs or commas)
CASE 2: AERODRONE TECH
AeroDrone Tech is an ungeared manufacturer of commercial delivery drones. The company currently has a cost of equity of 12%. The board is considering a major restructuring to issue debt and repurchase equity. The corporate tax rate is 25%. The risk-free rate is 4% and the equity risk premium is 6%.
AeroDrone's latest financial statements show Operating Profit (EBIT) of $5,000,000. Depreciation was $800,000. Capital expenditure was $1,200,000 and the working capital requirement increased by $300,000.
Calculate AeroDrone Tech's Free Cash Flow to the Firm (FCFF).
(Enter your answer as a whole number without dollar signs or commas)
How to approach this question
Use the formula: FCFF = EBIT(1 - tax) + Depreciation - Capital Expenditure - Increase in Working Capital.
Full Answer
1. Calculate NOPAT (Net Operating Profit After Tax): EBIT × (1 - Tax rate) = $5,000,000 × (1 - 0.25) = $3,750,000.
2. Add back non-cash charges (Depreciation): $3,750,000 + $800,000 = $4,550,000.
3. Deduct Capital Expenditure: $4,550,000 - $1,200,000 = $3,350,000.
4. Deduct Increase in Working Capital: $3,350,000 - $300,000 = $3,050,000.
Common mistakes
Forgetting to apply tax to EBIT, or adding working capital increases instead of subtracting them.
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