Question

An analyst is trying to value Jason’s Specialties (JS) stock. The analyst has collected data from the company and other sources to prepare the below financials, both actual and projected. Based upon these sources, the analyst expects the company’s free cash flows to grow at 4% on average. The analyst has estimated the company’s cost of capital (WACC) to be 16% and its cost of equity to be 21%. The risk-free rate is 2.3%..

1. Which items listed under Current Assets and Current Liabilities are typically excluded from NOWC? What is JS’s NOWC in years 2019 and 2020?
2. Compute the firm’s FCF (free cash flow) for year 2020.
3. Find the value of the firm using DCF method and price per share assuming that there are 10,000,000 shares issued and outstanding.
4. Find the value of the firm using ECF method and price per share assuming that there are 10,000,000 shares issued and outstanding
5. What is the External Financing Needed for year 2020? Explain your calculation
6. Suppose that the firm's probability of bankruptcy is estimated to be 5% and the economic loss associated with bankruptcy is likely to amount to $55,000,000. What valuation method would allow you to take this into account? Describe briefly how you would implement it (you do not have enough information to actually do the calculations, so no need to try).

Income statement for the fiscal year ending January 1 (Millions of dollars)

2019 (Actual)		2020 (Projected)
Net Sales	$400.0		$430.0
Costs	260.0		283.5
Depreciation	37.5		42.5
Earnings before interest and taxes	102.5		104.0
Interest expense	14.1		16.0
Earnings before taxes	88.4		89.9
Taxes (40%)	35.36		35.2
Net income before preferred dividends	53.04		52.8
Preferred dividends	6.0		6.5
Net income	47.04		46.3
Common dividends	37.632		38.2
Addition to retained earnings	9.0408		8.1

Balance sheets for the fiscal year ending January 1 (Millions of dollars)

2019 (Actual)		2020 (Projected)
Cash	$6.3		$3.6
Marketable Securities	40.9		39.128
Accounts Receivable	62.0		67.0
Inventories	107.0		105.5
Net plant & equipment	391.0		415.36
Total Assets	607.2		630.58
Accounts payable	9.6		12.1
Accruals	25.5		29.1
Long-term bonds	210.7		217.78
Preferred Stock	55		57.1
Common Stock (Par plus PIC)	160.0		160.0
Retained earnings	146.4		154.5
Total Liabilities & Equity	607.2		630.58

Answer 1

Q1. Which items listed under Current Assets and Current Liabilities are typically excluded from NOWC?

Ans - Marketable securities, it is a non-operating asset.

Q2. What is JS’s NOWC in years 2019 and 2020?

NOWC = Operating Current Assets - Operating Current Liabilities

From the given Above, Operating current assets are Cash, Accounts Receivable, Inventories

and Operating current liabilities are Accounts Payable and Accruals

So, NOWC 2019 = (6.3 + 62 + 107) - (9.6 + 25.5) = 175.30 - 35.1 c $ 140.20 Millions

  NOWC 2020 = (3.6 + 67 + 105.5) - (12.1 + 29.1) = 176.10 - 41.2 = $ 134.90 Millions

Q3. Compute the firm’s FCF (free cash flow) for year 2020.

Net Income    46.30

Plus: Net Interest after tax [16 (1-0.40)] 9.60

Plus: Depreciation    42.50

Add : Change in net working capital        7.08

(2020 working capital of $174.02 - 2019 working capital of $ 181.10 = -7.08 )

Less: Capital expenditures 66.86

( = PP&E (current period) – PP&E (prior period) + Depreciation (current period))

(= 415.36 - 391.0 + 42.5)

___________________

Free cash flow of Firm $ 38.62 Millions

Q4. Find the value of the firm using DCF method and price per share assuming that there are 10,000,000 shares issued and outstanding.

Terminal value = Free Cash Flow (1+g) / (WACC−g)
Terminal Value = 38.62 ( 1+ 0.04) / 0.16 - 0.04  = $ 334.71 Millions

Discount the terminal Value to today i.e by 1 year = 334.71/ ( 1+ 0.16) = $ 329.44 Millions = $ 329,440,000

Price Per share = $ 329,440,000 / 10,000,000 = $32.944 per share.