Question

Dewey Corp. is expected to have an EBIT of $2.45 million next year. Depreciation, the increase in net working capital, and capital spending are expected to be $180,000, $85,000, and $185,000, respectively. All are expected to grow at 18 percent per year for four years. The company currently has $13 million in debt and 800,000 shares outstanding. The company’s WACC is 9.1 percent and the tax rate is 21 percent. You decide to calculate the terminal value of the company with the price-sales ratio. You believe that Year 5 sales will be $27.4 million and the appropriate price-sales ratio is 1.9. What is your estimate of the current share price?

Answer 1

Expected FCF, FCF1 = EBIT * (1 - Tax Rate) + Depreciation - Increase in Net Working Capital - Capital Spending
Expected FCF, FCF1 = $2,450,000 * (1 - 0.21) + $180,000 - $85,000 - $185,000
Expected FCF, FCF1 = $1,845,500

Growth Rate for next 4 years = 18%

FCF2 = $1,845,500 * 1.18 = $2,177,690
FCF3 = $2,177,690 * 1.18 = $2,569,674
FCF4 = $2,569,674 * 1.18 = $3,032,215
FCF5 = $3,032,215 * 1.18 = $3,578,014

Price-Sales Ratio = Horizon Value in Year 5 / Sales in Year 5
1.90 = Horizon Value in Year 5 / $27,400,000
Horizon Value in Year 5 = $52,060,000

WACC = 9.10%

Value of Firm = $1,845,500/1.091 + $2,177,690/1.091^2 + $2,569,674/1.091^3 + $3,032,215/1.091^4 + $3,578,014/1.091^5 + $52,060,000/1.091^5
Value of Firm = $43,635,640

Value of Equity = Value of Firm - Value of Debt
Value of Equity = $43,635,640 - $13,000,000
Value of Equity = $30,635,640

Price per share = Value of Equity / Shares Outstanding
Price per share = $30,635,640 / 800,000
Price per share = $38.29

So, the estimated current share price is $38.29