To: Dr. Lynna Martinez Subject: Calaveras Vineyards Valuation As per your request, my associates and I have calculated a valuation for Calaveras Vineyards using the present value of cash flows. We used the valuation of future cash flows method in order to value to value the company. We have come to the conclusion, based on a number of future projections, that the best valuation of the vineyards is $4,356,000 in assets and $1,104,000 in equity. The process at determining this valuation was as follows: 1.
First, using the projected EBIT forecasted income statement; we took out the 37% tax, change in working capital, and CAPEX for 1994-1998 and added back the depreciation and amortization expenses to arrive at free cash flows. We assumed that 1996-1998 would need an extra 100k in CAPEX in order to project the reinvestment necessities for the company. 2. In order to discount those free cash flows, we had to find the discount rate of the company using a weighted average unlevered Beta, and the risk free rate vs. the market risk premium: a.
Beta: This was determined by using the three comparable companies and their unlevered betas as a percentage of what product lines they relate to. b. The risk free rate was taken from the standard 30 year T-bonds rate of 5. 85%. c. The risk premium used was the expected return of small companies less the return of long term government bonds, which was 7. 4% historically from 1926 to 1992. All of these values were used to calculate a discount rate of 14. 5% for Calaveras which was used to discount the cash flows. The total discounted cash flows equal $1,585,000 for 1994-1998. 3.
Next, the tax shield for Calaveras was calculated by using the interest payments for each year and multiplying each value by the company’s tax rate of 37%. It was assumed that we used the 9. 5% interest rate, per your suggestion, instead of the average interest expense provided in the projected income statement. These future values were then discounted using the interest rate. The total PV of tax shield for 1994-1998 valued at $383,000. 4. For the terminal value calculation, we chose to use a range of growth rates. The range that we chose to use for growth rates was 1%, 1. 5%, 2%, and 2. %. We believe that Calaveras will continue to produce a high quality wine upholding a strong brand name and position in the market. Along with this, we believe that the wine industry as a whole will be growing into the future because of a growing economy. These rates represent indefinite growth; therefore, we are positioning your company to be growing slightly above the industry average. The free cash flow that we used to calculate the terminal value was from the year 1997. We did this because we felt that the cash flow in 1998 was not a true representation of future cash flows.
In 1998, there was a large drop in current liabilities due to the drop in current loans; this caused the change in working capital to be unusually high. We believe, Calaveras will return to normal levels of working capital. This will be after the new marketing push and establishment of more revolving line of credit for planned future growth in sales. 5. We discounted the terminal values of free cash flows at the same discount rate that we discounted the free cash flows. We then averaged the range of present value terminal values to get an average present terminal value of free cash flows. This value was $1,820,000.
We then calculated the terminal values of the interest tax shields by taking the 1998 interest tax shield and using the terminal value equation, with a discount rate of 9. 5% because we discount interest tax shield using the interest rate. This then gave us a range of terminal values of the interest tax shield. The average was $568,000. In conclusion, the PV of FCF (1585k), the PV of TS benefits (383k), PV of TV of CF (1820k), and PV of TV of TS (568k) all total to a current asset value of $4,356,000 for Calaveras Vineyards. Please feel free to let us know if you have any further questions or requests per the Calaveras’ valuation.