Genoa Pasta manufactures Italian food products and currently earns $60 million in earnings before interest and taxes. You expect the firm's earnings to grow 15 percent a year for the next five years and 3% thereafter. The firm's current after-tax return on capital is 30%, but you expect it to be halved after the sixth year. Assume a cost of capital for the firm of 12%. The tax rate for the firm is 35%.
a) What factors drive the length of the period of above normal growth? In other words how do we decide how long this period lasts?
b) What is your estimate of the terminal value for Genoa Pasta?
c) Should the changes in net fixed assets and net working capital in calculating the terminal cash flow be positive or negative (a cash inflow or outflow)? Why?
d) If a firm is interested in increasing their value is it better to focus on growing cash flow or sales? Is there a limit to potential improvements in efficiency?