Question

The following is a four- year forecasted estimate for ABC limited.

YEAR	Free cash flow (Sh’ Millions)
2019	30
2020	76
2021	92
2022	112

Required

1. Estimate the fair market value of ABC limited at the end of 2018. Assume that after 2022 earnings before interest and tax will remain constant at Sh. 200 million, depreciation will equal capital expenditure in each year and working capital will not change. The weighted average cost of capital for the company is 11% and its tax rate is 30%.

2. Estimate the fair market value per share of the company’s equity at the end of 2018 if the company has 40 million shares outstanding and the market value of interest-bearing liabilities on the valuation date equals Sh. 300 million. (10 Marks)

Answer 1

First we calculate free cash flow to firm (FCFF) for 2023 and beyond.

FCFF = earnings before interest and tax or EBIT*(1-tax rate) + Depreciation - change in working capital - capital expenditure

Depreciation and capital expenditure are same. so it's value will be zero because same amount will be added and subtracted. also working will not change. hence change in working capital will also be zero.

FCFF = 200*(1-0.30) + 0 - 0 - 0 = 200*0.70 = 140

next we calculate terminal value of free cash flows of 2023 and beyond. EBIT will remain constant. so growth rate in EBIT will be zero.

terminal value = FCFF/(weighted avg. cost of capital(WACC) - growth rate) = 140/(0.11 - 0 ) = 140/0.11 = $1,272.73

fair market value of ABC limited at the end of 2018 = FCFF 2019/(1+WACC)¹ + FCFF 2020/(1+WACC)² + FCFF 2021/(1+WACC)³ + FCFF 2022/(1+WACC)⁴ + terminal value/(1+WACC)⁴

fair market value = 30/1.11¹ + 76/1.11² + 92/1.11³ + 112/1.11⁴ + 1,272.73/1.11⁴

fair market value = 30/1.11 + 76/1.2321 + 92/1.3676 + 112/1.5181 + 1,272.73/1.5181

fair market value = 27.03 + 61.68 + 67.27 + 73.78 + 838.37 = $1,068.13 million

Fair market value per share of the company's equity = (Fair market value of company - market value of debt)/no. of shares outstanding

Fair market value per share of the company's equity = ($1,068.13 - $300)/40 = $768.13/40 = $19.20