C4 Finance: FROMA
FROMA is a small business that provides soft goods (straps and pack systems) to military buyers. They are
considering several di↵erent investments and have asked you for your help in evaluating the impact, as their
CFO is part-time and does not have the capacity to advise the owner on this matter.
Due to constraints on management oversight, only one of the investments can be made. The owner has had
conversations with various sources of capital for the di↵erent investments. The investment alternatives are
listed in the table below, along with the funding source(s) and the returns that each funding source expects.
FROMA’s part-time CFO has provided you with the following information:
• Weighted Average Cost of Capital (WACC) is assumed to be 10%.
• A recent balance sheet (see supplemental information section) and the most recent profit and loss
statement (see supplemental information section), and the current five year profit and loss forecast
(which assumes no investment project is pursued).
• Cash flow assumptions of each investment alternative (see supplemental information section).
• Any debt that FROMA has or takes on is coupon debt – there will be no principal repayment requirements, only annual interest.
• All existing and future fixed assets have a assumed depreciable life of 10 years and all existing assets
have been purchased within the last two years.
C4 Finance: FROMA
Write a report addressing the content requirements listed below. Your report should be properly formatted
into sections that are congruent with the content requirements. This is a professional business report, not
a book report or creative writing assignment. Feel free to use your own style, but the report should be
professional and well-written.
This assignment should be prepared as a business report with schedules.
Submit a pdf of your report to the appropriate dropbox on Moodle before the in-class due date/time.
Grading will be based upon:
• Satisfaction of requirements listed below.
• Quality of analysis, discussion, and estimation methods.
• Quality of report organization and layout.
• Proper grammar and spelling; style and flow; sentence construction; concise but complete.
• Editing – good writing is rewriting!
Graphics and other visualizations are not an absolute requirement (unless otherwise specified), but your
grade will be positively a↵ected by the use of e↵ective visualizations.
Make certain you appropriately show relevant calculations. If you find it difficult to present calculations
using software, you may handwrite your calculations and include those calculations in your pdf. Utilizing an
appendix is an excellent way to provide supplemental information (such as detailed calculations) in a report.
Another option to show calculations is to cut/paste an excel schedule as an image into Microsoft Word, with
written commentary as appropriate.
Tier 1 requirements (maximum grade of B+):
Write a report outlining your recommendations for investment. Include the following in your report:
1. Evaluate and rank each investment alternative using NPV, IRR, and payback, using the CFO-provided
WACC as the discount/hurdle rate. You should include calculations for each alternative.
2. Which investment would you recommend? Why?
3. Prepare a five year profit and loss statement forecast that incorporates the e↵ect of your recommended
investment alternative choice (ie, use the existing forecast and modify it for the e↵ects of the investment).
Use a 10 year depreciable life for any new fixed assets. Use 25% for the income tax rate (ignore other
taxes) and be sure to incorporate any interest costs as a result of your alternative choice.
4. Prepare a balance sheet forecast for the next five years using static (as a ratio of revenue) working
capital metrics and incorporating the future balance sheet e↵ects of your investment project choice.
For T1, you may ignore the cash account, but you should forecast all other lines of the balance sheet,
including all equity accounts, debt accounts, and non-cash assets.
C4 Finance: FROMA
5. Discuss the qualitative costs and benefits of the di↵erent sources of capital. Why might the owner forgo
the hard math of capital budgeting and choose one project (or one source of funds) over another?
Tier 2 requirements (maximum grade of A):
1. Complete all items from Tier 1.
2. Prepare a cash flow forecast using the balance sheet and income statement from Tier 1.
Tier 3 questions (A + extra credit / final exam exemption):
1. Complete all items from Tier 2 and add the following to your report:
2. Using a valuation metric of 6x EBITDA, calculate the enterprise value (EV) of FROMA in year 5.
3. Assume the company is sold for the valuation you calculated in Tier 3, item 2. Prepare a schedule that
outlines the distribution of proceeds among investors that is consistent with your choice of investment
alternative from Tier 1, Item 2.
FROMA’s Current Balance Sheet
Figure 1: FROMA Balance Sheet
C4 Finance: FROMA
FROMA’s Current and Forecasted Profit and Loss Statement
Figure 2: FROMA Profit and Loss Actuals and Forecast
C4 Finance: FROMA
Cash Flow details for each investment alternative
Figure 3: FROMA Investment Alternatives Cash Flows
C4 Finance: FROMA
Supplemental information and tips:
Balance sheet forecasting
Working capital metrics (or ratios) are a way of indexing working capital level to sales. A/R days (360 · Sales
measures Accounts Receivable in relation to sales, in terms of days sales outstanding. Days inventory on
hand (DIOH) and A/P days work similarly.
If the ratio of working capital to sales does not change, but sales changes, we can expect changes in working
capital, and we can forecast those changes using working capital ratios.
Forecasting fixed capital is a simple exercise – consider any additions to your fixed capital base, and consider
the e↵ect of depreciation on accumulated depreciation. Forecasting debt is also a simple exercise – consider
what additions, if any, will be made to debt.
Enterprise value (EV, not to be confused with EV=expected value) is the total market value of the company
– what it is worth if sold. EV is comprised of the market value of debt plus the market value of equity.
Book value of debt+equity = assets, so EV, which uses market value instead of book value, should price
the company’s net assets at what the market thinks the net assets are worth. The market accounts for
many intangibles that accounting does not include when calculating balance sheet equity (book value). A
di↵erence arises between market value and book value because accounting is focused on reporting history
while company valuation attempts to find the present value of future cash flows.
Finance values a company as the present value of its future cash flows; accounting generally values assets at
historical value, with some mark to market adjustments.
Said another way, if you wanted to buy 100% of the company, you would have to pay the current investors
(debt and equity) the current market value of their investments. The sum of market value of debt and market
value of equity is therefore the current enterprise value of the company.
Note that there are many methods of valuing a company, including discounted cash flow (DCF) analysis and
multiples of earnings/EBITDA/FCF (EBITDA = earning before interest, taxes, depreciation, and amortization; FCF = free cash flow, or operating cash flow minus capital investments). EBITDA multiple is a common
metric for small private companies that is a quick and easy method that acts as a proxy for DCF approaches.
Price/earnings ratio (P/E ratio, sometimes called the P/E multiple) or PEG (price-earnings-growth) are
other valuation metrics commonly used for evaluating public companies.
Using multiples to value a company is not a theoretically correct approach; multiples do not consider heterogeneity of growth of future cash flows (although PEG does). Investors still use multiples due to their
simplicity, and may even have rules of thumb for multiple to apply based upon the company’s growth rate,
which mitigates the divergence from theoretical foundations (DCF and/or risk-adjusted models).
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