Paulson Industries Inc. is an established mid-level tech firm concentrating on the implementation of Artificial Intelligence (AI) and Augmented Reality (AR) platform analysis and distribution into automated manufacturing processes throughout the United States and Canada. It is based in Riverside, California for which the company originally was spun off from Magnum Industries, Inc. and then was sold to Ocean Intel Partners-a private equity firm before the original owners repurchased the firm eleven years ago. Due to location and the evolution of the company’s target market within the high-tech sector of the economy, the company concentrates its efforts on the single product line mentioned above. Paulson is motivated to diversify its product line up to create greater consistency of cash flows and hence reduce the overall level of risk; they theorize this will enhance its market value and overall appeal to the market while pursuing a transaction (sale of company) as the owners contemplate retirement and a new generation to lead the company.
Currently, Paulson has hired a market research firm (Boston Solutions, Inc.) to gauge an estimate of expected unit sales that they think will likely emerge over the next five years. Their work has resulted in an estimate of 165,487, 178,788, 164,369, 159,327 and 93,675 units respectively for the next five years conditioned on Paulson adhering to an average sales price of $412 per unit for the first two years and $349 in years three, four, and five. From that point going forward, growth in unit sales are predicted to be 2.85% indefinitely.
After the results of an internal company analysis by the Corporate Finance staff, it has been determined that the company can manufacture its product line at a variable cost per unit expected to be $143.50 growing at 4.05% per year for the first 5 years and 4.65% per year indefinitely thereafter while overall fixed costs are estimated to be $11,487,500 annually for the first year and then grow 3.94% per year indefinitely.
The necessary capital expenditures are projected to be $31,175,775 upfront and due to the nature of the investments that Paulson makes, it is deemed by the IRS to be depreciated on the seven-year MACRS schedule. In the terminal phase of growth, investment strategy will likely change to that of a maintenance orientation in support of AI/AR opportunities. As such, an average annual depreciation charge following a straight-line depreciation method is anticipated to be $1,167,750 reflecting a scaled down one-time 4-year investment strategy.
Working capital to support sales is estimated to be 11.27% of yearly sales for the first 5 years and then is projected to slow to a 3.89% annual growth rate thereafter.
The marginal corporate income tax rate is expected to average 21.67% barring any changes to the corporate tax code and the projected annual growth rate of Free Cash Flow (FCF) in the terminal phase is expected to grow approximately the current risk-free rate of return indefinitely. Historically, the debt-equity ratio has averaged roughly 163% for which Paulson’s current debt level is $12,678,991 with an average maturity of 6 years and an interest rate on this debt averaging 9.47%. Upon a regression analysis, the historical equity Beta was calculated to be 2.135, while the risk-free rate of return is given as 2.5625% and the market rate of return is assumed to be 12.225%%. Currently there are 3,461,228 shares of common stock outstanding.
You have been hired by Paulson Industries Inc. to determine the following:
1) Operating Cash Flow for each of the first 5 years and the Terminal Phase
2) Free Cash Flow for each of the first 5 years and the Terminal Phase
3) What the Asset Beta (Industry Beta) is that can use in its analysis
4) What the appropriate discount rate is for valuing the firm and hence stock price
5) What the asset value of the firm is
6) What the equity value of the firm is
7) What the appropriate stock price is
8) Make recommendations to improve the stock price