Sothin and Sons

Sothin and Sons
The value of a firm can be inferred from its financial statement, by determining the net present
value of its Free Cash Flow. Let us do this for Sothin and Sons. From the results, examine how
the firm's value may be increased or decreased by any action to alter the projected values.
This exercise was written as a basis for class discussion. It illustrates neither the effective nor ineffective
management of the given situation. Data provided may be entirely hypothetical.
LeongTY 493131561.xlsx/Home
Financial Statement
Year 1995 1996 1997 1998 1999 2000 2001

Income Statement
Sales
Product sales 6,076,345 18,977,564 28,048,500 42,021,000 55,993,500 69,966,000 83,938,500
Other income 131,326 176,111
Total sales 6,207,671 19,153,675
Operating expenses
Costs of goods sold -2,461,470 -7,839,481
Depreciation -400,000 -1,303,085
Selling, general and admin -1,866,614 -6,045,369
Interest expense -50,763 -84,606
Interest income 100,812 171,362
Earnings before income tax 1,529,636 4,052,496
Provision for income tax -631,740 -1,693,943
Profit after tax 897,866 2,358,553
Balance Sheet
Current assets
Cash and cash equivalents 2,016,245 3,023,989
Accounts receivable 1,278,771 4,194,238
Inventory 185,314 759,104
Prepaid expenses and other current assets 392,116 1,006,169
Property and equipment

At cost 4,000,000 13,030,853
Accumulated Depreciation -400,000 -1,703,085
Net property and equipment 3,600,000 11,327,768
Total assets 7,472,446 20,311,268
Current liabilities
LeongTY 493131561.xlsx/Data
Accounts payable and accrued expenses 906,648 3,271,271
Income tax payable 157,935 423,486
Other current liabilities 52,910 151,189
Long-term debt 846,058 8,597,874
Stockholders' equity
Common stock 4,610,999 4,610,999
Retained earnings 897,896 3,256,449
Total Liabilities and equity 7,472,446 20,311,268
LeongTY 493131561.xlsx/Data
Financial Pro forma © 2007 Leong Thin Yin. All rights reserved.
Ratio Analysis Past Future Sales ≈ Product sales

Cost of goods sold/Sales 39.7% 40.9% 40.0% 40.0% 40.0% 40.0% 40.0%
Depreciation/Sales 6.4% 6.8% 10.0% 10.0% 10.0% 10.0% 10.0%
Selling, general and admin/Sales 30.1% 31.6% 32.0% 31.0% 30.0% 29.0% 28.0%
Interest rate (expense) 6.0% 1.0% 12.0% 12.0% 12.0% 12.0% 12.0%
Interest rate (income) 5.0% 5.7% 6.0% 6.0% 6.0% 6.0% 6.0%
Provision for income tax / Earnings before tax 41.3% 41.8% 41.5% 41.5% 41.5% 41.5% 41.5%
Cash and cash equivalents/Sales 32.5% 15.8% 20.0% 15.0% 10.0% 10.0% 10.0%
Accounts receivable/Sales 20.6% 21.9% 22.0% 22.0% 22.0% 22.0% 22.0%
Inventory/Sales 3.0% 4.0% 4.5% 5.0% 5.0% 5.0% 5.0%
Prepaid expenses/Sales 6.3% 5.3% 5.0% 5.0% 5.0% 5.0% 5.0%
Property and equipment at cost/Sales 64.4% 68.0% 62.4% 56.8% 51.2% 45.6% 40.0%
Accounts payable/Sales 14.6% 17.1% 18.0% 19.0% 20.0% 20.0% 20.0%
Income tax payable/Provision for income tax 25.0% 25.0% 25.0% 25.0% 25.0% 25.0% 25.0%
Other current liabilities/Sales 0.9% 0.8% 1.0% 1.0% 1.0% 1.0% 1.0%
-1 0 1 2 3 4 5
Year 1995 1996 1997 1998 1999 2000 2001
Income Statement
Sales
Product sales 6,076,345 18,977,564 28,048,500 42,021,000 55,993,500 69,966,000 83,938,500
Other income 131,326 176,111
Total Sales 6,207,671 19,153,675
Operating expenses
Costs of goods sold (2,461,470) (7,839,481)
Depreciation (400,000) (1,303,085)
Selling, general and admin (1,866,614) (6,045,369)
Interest expense (50,763) (84,606)
Interest income 100,812 171,362
Earnings before income tax 1,529,636 4,052,496
Provision for income tax (631,740) (1,693,943)
LeongTY 493131561.xlsx/Proto

Inventory/Sales 3.0% 4.0% 4.5% 5.0% 5.0% 5.0% 5.0%
-1 0 1 2 3 4 5
Year 1995 1996 1997 1998 1999 2000 2001
Profit after tax 897,896 2,358,553
Balance Sheet
Current assets
Cash and cash equivalents 2,016,245 3,023,989
Accounts receivable 1,278,771 4,194,238
Inventory 185,314 759,104
Prepaid expenses and other current assets 392,116 1,006,169

At cost 4,000,000 13,030,853
Accumulated depreciation (400,000) (1,703,085)
Net property and equipment 3,600,000 11,327,768
Total assets 7,472,446 20,311,268

Inventory/Sales 3.0% 4.0% 4.5% 5.0% 5.0% 5.0% 5.0%
-1 0 1 2 3 4 5
Year 1995 1996 1997 1998 1999 2000 2001
Current liabilities
Accounts payable and accrued expenses 906,648 3,271,271
Income tax payable 157,935 423,486
Other current liabilities 52,910 151,189
Long-term debt 846,058 8,597,874
Common stock 4,610,999 4,610,999
Retained earnings 897,896 3,256,449
Total liabilities and equity 7,472,446 20,311,268
Questions
1. What are the performance ratio values for the next five years?
2. How did you work them out?
Ratio Analysis Past Future

Inventory/Sales 3.0% 4.0% 4.5% 5.0% 5.0% 5.0% 5.0%
-1 0 1 2 3 4 5
Year 1995 1996 1997 1998 1999 2000 2001
Income Statement
Sales
Product sales 6,076,345 18,977,564 28,048,500 42,021,000 55,993,500 69,966,000 83,938,500
Other income 131,326 176,111
Total Sales 6,207,671 19,153,675 28,048,500 42,021,000 55,993,500 69,966,000 83,938,500
Operating expenses
Costs of goods sold (2,461,470) (7,839,481) (11,219,400) (16,808,400) (22,397,400) (27,986,400) (33,575,400)
Depreciation (400,000) (1,303,085) (1,879,250) (2,815,407) (3,751,565) (4,687,722) (5,623,880)
Selling, general and admin (1,866,614) (6,045,369) (8,975,520) (13,026,510) (16,798,050) (20,290,140) (23,502,780)
Interest expense (50,763) (84,606) Err:523 Err:523 Err:523 Err:523 Err:523
Interest income 100,812 171,362 336,582 378,189 335,961 765,617 Err:523
Earnings before income tax 1,529,636 4,052,496 Err:523 Err:523 Err:523 Err:523 Err:523
Provision for income tax (631,740) (1,693,943) Err:523 Err:523 Err:523 Err:523 Err:523
LeongTY 493131561.xlsx/Model

Inventory/Sales 3.0% 4.0% 4.5% 5.0% 5.0% 5.0% 5.0%
-1 0 1 2 3 4 5
Year 1995 1996 1997 1998 1999 2000 2001
Profit after tax 897,896 2,358,553 Err:523 Err:523 Err:523 Err:523 13,359,552
Balance Sheet
Current assets
Cash and cash equivalents 2,016,245 3,023,989 Err:523 Err:523 Err:523 Err:523 Err:523
Accounts receivable 1,278,771 4,194,238 6,170,670 9,244,620 12,318,570 15,392,520 18,466,470
Inventory 185,314 759,104 1,262,183 2,101,050 2,799,675 3,498,300 4,196,925
Prepaid expenses and other current assets 392,116 1,006,169 1,262,183 2,101,050 2,799,675 3,498,300 4,196,925

At cost 4,000,000 13,030,853 17,509,708 23,876,292 28,676,102 31,909,138 33,575,400
Accumulated depreciation (400,000) (1,703,085) (3,582,335) (6,397,742) (10,149,306) (14,837,028) (20,460,908)
Net property and equipment 3,600,000 11,327,768 13,927,373 17,478,550 18,526,796 17,072,110 13,114,493
Total assets 7,472,446 20,311,268 Err:523 Err:523 Err:523 Err:523 Err:523

Inventory/Sales 3.0% 4.0% 4.5% 5.0% 5.0% 5.0% 5.0%
-1 0 1 2 3 4 5
Year 1995 1996 1997 1998 1999 2000 2001
Current liabilities
Accounts payable and accrued expenses 906,648 3,271,271 5,048,730 7,983,990 11,198,700 13,993,200 16,787,700
Income tax payable 157,935 423,486 Err:523 Err:523 Err:523 Err:523 Err:523
Other current liabilities 52,910 151,189 280,485 420,210 559,935 699,660 839,385
Long-term debt 846,058 8,597,874 Err:523 Err:523 Err:523 Err:523 Err:523
Common stock 4,610,999 4,610,999 4,610,999 4,610,999 4,610,999 4,610,999 4,610,999
Retained earnings 897,896 3,256,449 Err:523 Err:523 Err:523 Err:523 Err:523
Total liabilities and equity 7,472,446 20,311,268 Err:523 Err:523 Err:523 Err:523 Err:523
Additional cash Err:523 Err:523 Err:523 Err:523 Err:523

Inventory/Sales 3.0% 4.0% 4.5% 5.0% 5.0% 5.0% 5.0%
-1 0 1 2 3 4 5
Year 1995 1996 1997 1998 1999 2000 2001
Can we remove this irregular additional row above?
Cost of goods sold/Sales
100%
Depreciation/Sales
90%
Selling, general and admin/Sales
80%
Interest rate (expense)
70% Interest rate (income)
60% Provision for income tax / Earnings before tax
Cash and cash equivalents/Sales

50%
Accounts receivable/Sales
40%
Inventory/Sales
30%
Prepaid expenses/Sales
20% Property and equipment at cost/Sales
10% Accounts payable/Sales
Income tax payable/Provision for income tax

0%
1994 1995 1996 1997 1998 1999 2000 2001 2002 Other current liabilities/Sales
Questions
1. What are the performance ratio values for the next five years?
2. How did you work them out?
Documentation
Cost of goods sold / Sales E4 <Input>
Depreciation / Sales E5 <Input>
Selling, general and admin / Sales E6 <Input>
Interest rate (expense) E7 <Input>
Interest rate (income) E8 <Input>
Provision for income tax / Earnings before tax E9 <Input>
Cash and cash equivalents / Sales E10 <Input>
Accounts receivable / Sales E11 <Input>
Inventory / Sales E12 <Input>
100%
Depreciation/Sales
90%
80%

50%
40%
Inventory/Sales
30%

0%
Questions
Prepaid expenses / Sales E13 <Input>
Property and equipment at cost / Sales E14 <Input>
Accounts payable / Sales E15 <Input>
Income tax payable / Provision for income tax E16 <Input>
Other current liabilities / Sales E17 <Input>
Product sales E23 <Input>
Other income E24 <Input>
Total sales E25 =SUM(E23:E24)

Costs of goods sold E28 =-E4*E$25
Depreciation E29 =-E5*E$25
Selling, general and admin E30 =-E6*E$25
Interest expense E31 =-E7*E54
Interest income E32 =E8*SUM(E39,E61)
100%
Depreciation/Sales
90%
80%

50%
40%
Inventory/Sales
30%

0%
Questions
Earnings before income tax E33 =SUM(E25,E28:E32)
Provision for income tax E34 =-E9*E33
Profit after tax E35 =E33+E34
Cash and cash equivalents E39 =E10*E$25+E61
Accounts receivable E40 =E11*E$25
Inventory E41 =E12*E$25
Prepaid expenses and other current assets E42 =E12*E$25
Property and equipment at cost E45 =E14*E$25
Accumulated depreciation E46 =D46+E29
Net property and equipment E47 =E45+E46
Total Assets E48 =SUM(E39:E42,E47)
Accounts payable and accrued expenses E51 =E15*E$25
Income tax payable E52 =-E16*E34
Other current liabilities E53 =E17*E$25
100%
Depreciation/Sales
90%
80%

50%
40%
Inventory/Sales
30%

0%
Questions
Long-term debt E54 =MAX(0,E48-SUM(E51:E53)-E57-E58)
Common stock E57 =$C57
Retained earnings E58 =D58+E35
Total liabilities and equity E59 =SUM(E51:E58)
Additional cash E61 =MAX(0,-E48+SUM(E51:E53)+E57+E58)
Valuation © 2007 Leong Thin Yin. All rights reserved.
Cost of Capital NPV Free cash flow

20.0% Err:523 Err:523 Err:523 Err:523 Err:523 Err:523
0 1 2 3 4 5
Year 1995 1996 1997 1998 1999 2000 2001
Profit after tax 897,896 2,358,553 Err:523 Err:523 Err:523 Err:523 13,359,552
+ Depreciation 400,000 1,303,085 1,879,250 2,815,407 3,751,565 4,687,722 5,623,880
+ Interest expense, net of taxes 38,072 63,454 Err:523 Err:523 Err:523 Err:523 Err:523
- Interest cost, net of taxes (75,609) (128,521) (252,437) (283,642) (251,971) (574,213) Err:523
- Current assets change (5,111,054) Err:523 Err:523 Err:523 Err:523 Err:523
+ Current liabities change 2,728,453 Err:523 Err:523 Err:523 Err:523 Err:523
- Property and equipment at cost change (9,030,853) (4,478,855) (6,366,584) (4,799,810) (3,233,036) (1,666,262)
Questions
1. Why is this model correct?
2. How would you account for FCFs after 2001?
Documentation
Cost of capital C4 <Input>
NPV D4 =NPV(C4,E4:I4)*(1+C4)^0.5
Free cash flow E4 =SUM(E8:E14)
Profit after tax E8 =Model!E35
+ Depreciation E9 =-Model!E29
+ Interest expense, net of taxes E10 =-Model!E31*(1-Model!E16)
- Interest cost, net of taxes E11 =-Model!E32*(1-Model!E16)
- Current assets change E12 =-(SUM(Model!E39:E42)-SUM(Model!D39:D42))
+ Current liabilities change E13 =SUM(Model!E51:E53)-SUM(Model!D51:D53)
- Property and equipment at cost change E14 =-(Model!E45-Model!D45)
LeongTY 493131561.xlsx/Valuation

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Sothin and Sons

Year 1995 1996 1997 1998 1999 2000 2001

Property and equipment

Total assets 7,472,446 20,311,268

Long-term debt 846,058 8,597,874

Ratio Analysis Past Future Sales ≈ Product sales

Ratio Analysis Past Future Sales ≈ Product sales

Property and equipment

Ratio Analysis Past Future Sales ≈ Product sales

Ratio Analysis Past Future

Ratio Analysis Past Future

Property and equipment

Ratio Analysis Past Future

Additional cash Err:523 Err:523 Err:523 Err:523 Err:523

Ratio Analysis Past Future

70% Interest rate (income)

60% Provision for income tax / Earnings before tax

Cash and cash equivalents/Sales

20% Property and equipment at cost/Sales

10% Accounts payable/Sales

Income tax payable/Provision for income tax

70% Interest rate (income)

60% Provision for income tax / Earnings before tax

Cash and cash equivalents/Sales

20% Property and equipment at cost/Sales

10% Accounts payable/Sales

Income tax payable/Provision for income tax

Total sales E25 =SUM(E23:E24)

70% Interest rate (income)

60% Provision for income tax / Earnings before tax

Cash and cash equivalents/Sales

20% Property and equipment at cost/Sales

10% Accounts payable/Sales

Income tax payable/Provision for income tax

70% Interest rate (income)

60% Provision for income tax / Earnings before tax

Cash and cash equivalents/Sales

20% Property and equipment at cost/Sales

10% Accounts payable/Sales

Income tax payable/Provision for income tax

Cost of Capital NPV Free cash flow

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