Question

In: Finance

All data is as of the end of the most recent period except for book equity,...

All data is as of the end of the most recent period except for book equity, which is beginning of most recent period.

Beginning period of book equity

$25,000

Net Income

$2,500

Depreciation and amortization

$1,010

Fixed capital investments

$1,500

Working capital investment

$875

Internet expense

$300

Tax rate

40%

Net borrowing

$250

Dividends

$1,000

Common share outstanding

1,000

Risk free rate

3.25%

Market risk premium

6.00%

Beta

1.5

Expected growth in FCFE (constant)

5.00%

a. Value the stock 9price per share) using the single stage Gordon Growth Dividend Model. The growth in dividend needs to be estimated from the sustainable long term growth in dividends, which you can estimate using the data above.

b. Find FCFF and FCFE for the most recent period.

c. Value the stock (Price per share) using the single stage FCFE growth model. The growth rate in FCFE is expected to be 5% forever.

Expert Solution

a) Value of Stock using Single Stage Gordon Growth Model

Book Equity = $ 25000

Net Income = $2500

ROE (r) = Net Income/ Book Equity

= 2500/25000

= 10%

Dividend = $1000

Dividend Payout Ratio = Dividend/ Net Income

= $ 1000/ $ 2500

= 40 %

Retention Ratio (b)= 1-Dividend Payout Ratio

= (1-0.40)

= 0.60 i.e. 60%

Growth Rate (g) = ROE * Retention Ratio

= 0.10*0.60

= 0.06 i.e. 6%

Risk Free Rate (R_f) = 3.25%

Market Risk Premium (R_m-R_f) = 6%

Beta (β) = 1.5

Required Return (Re) = (R_f) + (R_m-R_f)β

= 3.25 +(6)1.5

= 12.25%

Dividend Current Year (D₀) = $1 per share ($1000/1000 shares)

Dividend Next Year (D₁) = D₀(1+g)

= 1(1.06)

= $ 1.06

Stock Price = D₁/(Re-g)

= $1.06/ (0.1225-0.06)

= = $1.06/ (0.0625)

= $ 16.96

Answer : Value of Stock = $ 16.96

b) Computation of FCFF and FCFE

i) FCFF

Calculation of NOPAT

Particulars	Amount ($)
Net Income	2500
PBT (Net Income)/(1-Tax)	4166.67
Add : Interest Expenses	300
EBIT (PBT + Interest Exp)	4466.67
NOPAT (EBIT)(1-Tax Rate)	2680

FCFF = NOPAT + Depreciation and Amortization – Capital Expenditure – Change in Net Working Capital

= 2680 + 1010 - 1500 – 875

= $1315

ii) FCFE

FCFE = Net Income + Depreciation and Amortization -Capital Expenditure - Change in Net Working Capital + Net Borrowings

= 2500 + 1010 - 1500 – 875 + 250

= $ 1385

c) Stock Price Using FCFE Approach

FCFE₀ = $1385

Re = 12.25 % (as calculated above)

Growth Rate (g) = 5% (given in the question)

FCFE₁ = FCFE₀ (1 + g)

= $1385 (1.05)

= $ 1454.25

Value of the firm = FCFF₁/(Re-g)

= $ 1454.25/(0.1225-0.05)

= $ 20058.62

No of Shares = 1000

Value Per Share = Value of Firm/No of Shares

= $ 20058.62/1000

= $ 20.05 (approx.)

Answer : Stock Price Per Share using FCFE approach = $ 20.05

jeff jeffy answered 10 months ago

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