TABLE 19.

1 Free cash flow projections and company value for Rio Corporation ($ millions)
Note: You can change any of the cells shaded green.

Latest
year Forecast
0 1 2 3 4 5 6 7

1. Sales 83.6 89.5 95.8 102.5 106.6 110.8 115.2 118.7

2. Cost of goods sold 63.1 66.2 71.3 76.3 79.9 83.1 87.0 90.2
3. EBITDA (1 - 2) 20.5 23.3 24.4 26.1 26.6 27.7 28.2 28.5
4. Depreciation 3.3 9.9 10.6 11.3 11.8 12.3 12.7 13.1
5. Profit before tax (EBIT) (3 - 4) 17.2 13.4 13.8 14.8 14.9 15.4 15.5 15.4
6. Tax 6.0 4.7 4.8 5.2 5.2 5.4 5.4 5.4
7. Profit after tax (5 - 6) 11.2 8.7 9.0 9.6 9.7 10.0 10.1 10.0

8. Investment in fixed assets 11.0 14.6 15.5 16.6 15.0 15.6 16.2 15.9
9. Investment in working capital 1.0 0.5 0.8 0.9 0.5 0.6 0.6 0.4
10. Free cash flow (7 + 4 - 8 - 9) 2.5 3.5 3.2 3.4 5.9 6.1 6.0 6.8

PV Free cash flow, years 1-6 20.3 (Horizon value in year 6)

PV Horizon value 67.6 113.4
PV of company 87.9

Assumptions:
Sales growth (percent) 6.7 7.0 7.0 7.0 4.0 4.0 4.0 3.0
Costs (percent of sales) 75.5 74.0 74.5 74.5 75.0 75.0 75.5 76.0
Working capital (percent of sales) 13.3 13.0 13.0 13.0 13.0 13.0 13.0 13.0
Net fixed assets (percent of sales) 79.2 79.0 79.0 79.0 79.0 79.0 79.0 79.0
Depreciation (percent of net fixed assets) 5.0 14.0 14.0 14.0 14.0 14.0 14.0 14.0

Tax rate, percent 35.0

Cost of debt, percent (rD) 6.0
Cost of equity, percent (rE) 12.4
Debt ratio (D/V) 0.4
WACC, percent 9.0
Long-term growth forecast, percent 3.0

Fixed assets and working capital

Gross fixed assets 95.0 109.6 125.1 141.8 156.8 172.4 188.6 204.5
Less accumulated depreciation 29.0 38.9 49.5 60.8 72.6 84.9 97.6 110.7
Net fixed assets 66.0 70.7 75.6 80.9 84.2 87.5 91.0 93.8
Net working capital 11.1 11.6 12.4 13.3 13.9 14.4 15.0 15.4
R a te s o f re t u rn , %
Figure 19.1 WACC at different debt-equity ratios

16.00
14.00
12.00
rE
10.00
rD
8.00
WACC
6.00
r
4.00
2.00
0.00

Debt-equity ratio (D/V)

Opportunity cost Cost of Cost of

D/E D/V of capital (r) debt (rD) equity (rE) WACC
0 0.000 9.84 6 9.84 9.84
0.05 0.048 9.84 6 10.03 9.74
0.1 0.091 9.84 6 10.22 9.65
0.15 0.130 9.84 6 10.42 9.57
0.2 0.167 9.84 6 10.61 9.49
0.25 0.200 9.84 6 10.80 9.42
0.3 0.231 9.84 6 10.99 9.36
0.35 0.259 9.84 6 11.18 9.30
0.4 0.286 9.84 6 11.38 9.24
0.45 0.310 9.84 6 11.57 9.19
0.5 0.333 9.84 6 11.76 9.14
0.55 0.355 9.84 6 11.95 9.09
0.6 0.375 9.84 6 12.14 9.05
0.65 0.394 9.84 6.05 12.34 9.03
0.7 0.412 9.84 6.1 12.49 8.98
0.75 0.429 9.84 6.15 12.65 8.94
0.8 0.444 9.84 6.2 12.79 8.90
0.85 0.459 9.84 6.25 12.93 8.86
0.9 0.474 9.84 6.3 13.07 8.82
0.95 0.487 9.84 6.35 13.20 8.78
1 0.500 9.84 6.4 13.33 8.75
1.05 0.512 9.84 6.45 13.45 8.71
1.1 0.524 9.84 6.5 13.57 8.67
 1.15 0.535 9.84 6.55 13.68 8.64
1.2 0.545 9.84 6.6 13.79 8.61
1.25 0.556 9.84 6.65 13.89 8.57
1.3 0.565 9.84 6.7 13.99 8.54
1.35 0.574 9.84 6.75 14.08 8.51
1.4 0.583 9.84 6.8 14.17 8.48
1.45 0.592 9.84 6.85 14.25 8.45
1.5 0.600 9.84 6.9 14.33 8.42

Note: We arbitrarily assume that the expected return on the debt is initially flat and
then increases steadily.
os

rE
rD
WACC
r
initially flat and
 TABLE 19.2 APV valuation of Rio Corporation ($ millions)

Latest
year Forecast
0 1 2 3

Free cash flow 2.5 3.5 3.2 3.4

PV Free cash flow, years 1-6 19.7

PV Horizon value 64.6
Base-Case PV of company 84.3

Debt 51 50 49 48
Interest 3.06 3.00 2.94
Interest tax shield 1.07 1.05 1.03
PV Interest tax shields 5.0

APV 89.3

Assumptions:
Tax rate, percent 35.0
Opportunity cost of capital, percent (r) 9.84
Interest rate 6.0
rporation ($ millions)

Forecast
4 5 6 7

5.9 6.1 6.0 6.8

(Horizon value in year 6)

113.4

47 46 45
2.88 2.82 2.76
1.01 0.99 0.97