Question

Company V earned a net profit margin of 25% on sales of $25 million in its most recently ended fiscal year. Capital investment was $2.5 million and depreciation was $3 million. Investment in working capital is 10% of sales every year. Assume the following:

• Sales, net income, cap ex, depreciation and interest expense are expected to grow 10% every year for the next five years
• After five years sales, net income, cap ex, depreciation and interest expense will decline to a stable growth rate of 4% per year

The tax rate is 36%. Company Z has 1.5 million shares of common stock outstanding. Company Z also has long-term debt paying 10% interest and it is trading at its par value of $30 million.

Calculate the value of the firm and its equity assuming the cost of capital is 15% during years 1-5 and 12% during the stable stage.

Answer 1

Cash Out flow= capital investment=$2.5 Million

a.Net Income =Net profit margin*sales=$25 million*25%=$6.25 million

b.Add Intesest expenses =$ 30 million @10%= $3 million

c.Earning before interest but after tax (a+b)=$9.25 million

d.tax rate @36%

therefore tax expenses=$9..25/1.36*36=$2.4485 million

EBIT= $9.25 million+$2.4485 million=$11.6985

e depreciation =$3 million

therefore cash flow =$11.6985+$3 million=$14.6985-10%of sales every year i.e.(2.5)(1+10%)⁵=$4.0626[adjusted on account of working capital increase]

therefore cash flow=$10.6722

PVAIF@15% for 5 years =1-1/(1+15%)⁵/15%=3.352

PVIF@12% for 5^th years =1/(1+5%)⁵ =0.567

X..Present value of cash out flow at year 1=$2.5 Million

Y. Present annuity value of cash inflow for 5 year @ 3.352*$10.6722(1+0.10)⁵= $57.6131 million

W.Present value of terminal cash flow at year 5 @ 0.567*$17.1876/15%-4% =$88.5943 million

[cash flow of year 5 th arrived as $10.6722(1+0.10)⁵ *(1+4%)=$17.1876 million cash  flow is arrived

terminal value of cash flow is arrived by formula+Free cash flow₅ *(1+g)/cost of capital-growth rate}

overall value of firm=Y+W=$57.6131 million+$88.5943=$146.2074{aggregate of discounted cash flow}

hence value of equity=value of firm-value of debt=$146.2074-$30 million=$116.2074

per share value of euity=$116.2074/1.5million shares=$97.4716