CMA Study Group

On January 1, 20X6, the board of Zodiac Company hired an investment analyst to advise the board on the value of the business. Selected projected financial data for the years of 20X6 through 20X8 are given below. Other information is: • Free cash flow is projected to grow 4.5% per year beginning with the year 20X9. • Zodiac's cost of capital is 8%. • Capital investment during 20X6 is projected to be $79.2. • Investment in non-cash working capital is expected to grow in line with growth in revenue (9% increase per year) • The company's tax rate is 30%. ($000 omitted) 20X6 20X7 20X8 Revenue (9% growth) $5,450.0 $5,940.5 $6,475.1 EBIT 327.0 356.4 388.5 Depreciation 65.0 70.9 77.2 Ending balance noncurrent assets - gross 1,345.2 1,440.2 1,554.2 Beginning balance non-cash working capital 220.0 239.8 261.4 Based on the information given above, Zodiac's total projected free cash flows for the years 20X6-20X8 is closest to (in $000):

Free cash flow is calculated as: EBIT × (1 − tax rate) − (Capital Expenditures − Depreciation) ± Change in Non-Cash Working Capital If non-cash working capital increases, the amount of the increase is a reduction to free cash flow. If non-cash working capital decreases, the amount of the decrease is an increase to free cash flow. Following is a calculation of expected free cash flows for the years 20X6-20X8: ($000 omitted) 20X6 20X7 20X8 EBIT (1 − tax rate) ($327.0×.70) $228.9 ($356.4×.70) $249.5 ($388.5×.70) $272.0 Less: (Capital Expenditures minus Depreciation (Capex 79.2−65.0 depr.) 14.2 (Capex [1,440.2−1,345.2] −70.9 depr.) 24.1 (Capex [1,554.2−1,440.2] −77.2 depr.) 36.8 Less: Increase in non-cash working capital ([220.0×1.09] −220.0) 19.8 ([239.8×1.09] −239.8) 21.6 ([261.4×1.09] −261.4) 23.5 Free cash flow $194.9 $203.8 $211.7 The total projected free cash flow for the three years is $194.9 + $203.8 + $211.7 = $610.4.