Task:
Calculating a company's firm price via the free cash flow model and via the residual income model. Please show work in Excel spreadsheet.
Assume Co. began operations on January 1, 2001 with $100 cash and $100 equity. On January 1, it purchased a machine for $60 cash and inventory for $40 cash. During 2001 it sold half the inventory for $50 cash. On December 31, it purchased $30 more inventory in cash and paid a $10 dividend.
During 2002 the company sold inventory costing $40 for $70 cash. It purchased $20 more in inventory and paid out a $10 dividend.
During 2003, it sold the remaining inventory for $60 cash. At the end of 2003, the machine had no further value and was scrapped. Co. decided to cease operations and to pay out a liquidating dividend equal to cash on hand. Please ignore the effect of income taxes.
Assuming that the machine is depreciated on a straight-line basis over 3 years with no salvage value, calculate the following (show your work):
2001 2002 2003 Beginning equity Net income Dividends Ending equity Residual income
Assume that on January 1, 2001 you were able to forecast Co.'s future transactions perfectly.
Question 1: Calculate the firm's price as of January 1, 2001 using the free cash flow model. Use a 10% discount rate (cost of capital).
Question 2: Calculate the price using the Residual income model. Use a 10% cost of capital. You should get the same price as in (1).