Financial Planning for Gonglou: Income Statement, Cash Flow, and Valuation

Determining the Income Statement for Gonglou in 2019

1: Determine the Income Statement of this company assuming that it is 2019 (year 0) and that the two founders do not scale up their business, hence no new machines (meaning that you should forget the forecasts for year 2020 and later in Table 2. Relax, later on we will work with the entire table). To determine the income statement in this case, you may assume that sales revenu will increase organically (without external funds) by 60% each year, up till year 10. Assume that COGS and Sales and Marketing expenditures remain proportional to sales using the proportions of 2019. For General and Administrative expenditures assume that costs decrease by 2% per year from 2020 on but that they cannot go below 10%.

 

2: For Working Capital, it is assumed that from year 2020 on WC decreases by 1% per year but WC can never be less than 5% of sales. Determine the operating cash flows for this business. You should also obtain a terminal cash flow. To do so, compute the growth rate of cash flows for the various years, and take the cash-flow growth rate between 2028 and 2029 as an estimate of the cash flow in 2030. Use Gordon-Shapiro to obtain the terminal cash flow for the end of 2029. To do so, assume that in the long- run the growth rate of CF is 10%. What is the value of this firm in 2019? What is the value at the end of 2029? How much could the two founders put into their pocket (before taxes) if they sold the company at the end of 2029?

 

3: Assume that by the beginning of 2019, the bank account of the firm is essentially reduced to 0. Determine the liquidity account for the next 10 years. Is this business sustainable?

Now, we assume that the firm will get scaled up and the development plan of the two founders materializes as planned.

To finance the purchase of machines of 500’000CHF, the two founders plan to ask a bank for a ten year loan. This loan will be for an amount of 500’000CHF.2 A famous Swiss bank is willing to lend such an amount to Gonglou as an annuity with a time horizon of 10 years. The annual fixed interest rates is set to 7%. This bank is willing to lend under the condition that the remaining debt outstanding after 3 years does not exceed 70% of WC. To simplify we assume that whatever the amount borrowed, interest rates charged by the bank do not change.

Calculating the Operating Cash Flows and Valuation of Gonglou in 2019 and 2029

 

4: Determine the Income Statement for this company given that you are at the beginning of 2019. To do so, project figures for the next 10 years. For the first years, you may use the projections used by Angela and David. After, that we need to get creative! To extrapolate revenu, you may again assume a growth rate of 60% after 2023. By the way, is this too conservative or too optimistic? You may extrapolate COGS, Sales-Marketing, and General Admin costs by assuming that they represent a constant fraction of revenu (their proportion being the one of 2023). Working Capital is supposed to decrease by 1% per year from year 5 on but not to become smaller than 5% of Sales Revenu.

 

5: Determine the operating cash flows.

 

6: You may assume a valuation of equity by the founders of 10mio in 2019. What is the WACC of this project?

 

7: Extrapolate the CF for 2030 using the growth rate of CF between 2028 and 2029. Using Gordon-Shapiro, determine the discounted value of all future CF by the end of 2029. Estimate again the present value of all these cash flows to determine the value of this firm in 2019. Clearly, this value only materializes if the bank finances the machine.

 

8: Establish the Liquidity Statement of this company for the first 10 years. You may assume that as of the time of the discussions with the bank, the bank account is essentially empty. Discuss your finding. What is the value of the firm after 10 years. What would be the amount of money the founders would walk away with if they sold the firm at the end of 2029?

 

9: Even though this case has more to do with company valuation than project choice, for pedagogical reasons, please, compute the IRR of the purchase of the machine assuming that all future cash flows are generated by the machine. You may restrict yourself to the IRR computation using only the first 10 years of CF.3 How could you determine the IRR if there is also a termination cash-flow?

 

10: Determine the Payback Time associated with the purchase of the machine.

The founders of Gonglou are also discussing with a business angel. Her first name is Caroline and, since she wishes to remain anonymous, we will refer to her as CG. She lives in Neucha?tel and is very understanding, yet she handles her business with a knowing hand. CG is willing to invest in this project if it appears interesting. We assume that CG has similar equity return requirements than the founders, that is 25%. We assume now that the business angel CG steps in instead of the bank.

 

11: Determine the Earnings Statement by adopting the exactly same assumptions concerning revenu growth, proportionality of costs, and evolution of WC than before in Part II. Determine the Cash Flow and Liquidity Statements for a given amount of cash given by the business angel.
How much money should CG chip in so that the Liquidity Statement remains positive over the next few years?

 

12: How many shares do you think CG is going to require for her contribution?

 

13: After ten years, if Gonglou gets sold, what is the value at which it gets sold? How much would the initial founders and CG get in this case?

 

14: Discuss the findings from above. Which road do you think Angela and David should/could take? What is your opinion concerning the plausibility of this financial plan?