Reference no: EM131127091

Wok Yow Imports, Inc., is a rapidly growing, closely held corporation that imports and sells Asian style furniture and accessories at several retail outlets. The equity owners are considering selling the venture and want to estimate the enterprise or entity value and then determine the value of the venture's equity. Following is last year's income statement (2010) and projected income statements for the next four years (2011-2014). Sales are expected to grow at an annual 6 percent rate beginning in 2015 and thereafter.

Selected balance sheet accounts at the end of 2010 are as follows: Required cash, accounts receivable, and inventory accounts totaled $50,000; net fixed assets were $50,000; and accounts payable and accruals totaled $25,000. Each of these accounts was expected to grow with sales over time. Long-term debt was $30,000, and there were 10,000 shares of common stock outstanding at the end of 2010.

Data have been gathered for Fine Furniture Products, a comparable publicly traded firm in Wok Yow's industry. Fine Furniture's risk index is judged to be 2.00, compared to a risk index of 1.00 for firms of average riskiness. Management believes that a 2.00 adjustment factor should be multiplied times the expected market risk premium for average firms to reflect Wok Yow's (and Fine Furniture's) relatively greater riskiness. Wok Yow's long-term debt to long-term capital (long-term debt plus equity) ratio was 40 percent at the end of 2010. The interest rate on long-term U.S. government bonds is 7 percent, Wok Yow could issue new longterm debt at a 12 percent rate, and the average expected market risk premium (common stocks over government bonds) is 7.5 percent for average firms.

A. Project Wok Yow's NOPAT statements for 2011 to 2015.

B. Determine the annual increases in required net working capital and capital expenditures (CAPEX) for Wok Yow for the years 2011 to 2015.

C. Project annual operating free cash flows to the entity for the years 2011 to 2015.

D. Management initially thought that an 18 percent discount rate was reasonable.

E. Use the information from Part D to estimate Wok Yow's terminal value cash flow at the end of 2014.

F. Estimate the firm's enterprise or entity value at the end of 2010.

G. Adjust the enterprise value to determine Wok Yow's equity value in dollars and on a per-share basis at the end of 2010.

H. Now estimate Wok Yow's after-tax cost of long-term debt. Use the risk-free rate, the expected market risk premium, and the risk index for Fine Furniture Company to estimate Wok Yow's cost of equity capital. Determine Wok Yow's weighted average cost of capital (WACC).

I. Reestimate Wok Yow's enterprise value using the WACC calculated in Part H. Then adjust the enterprise value to determine Wok Yow's equity value in dollars and on a per-share basis at the end of2010.