Question

Sora Industries has 67 million outstanding shares, $128 million in debt, $55

million in cash, and the following projected free cash flow for the next four years:

Year

0

1

2

3

4

Earnings and FCF Forecast ($ million)

1

Sales

433.0

468.0

516.0

547.0

574.3

2

Growth vs. Prior Year

8.1%

10.3%

6.0%

5.0%

3

Cost of Goods Sold

(313.6)

(345.7)

(366.5)

(384.8)

4

Gross Profit

154.4

170.3

180.5

189.5

5

Selling, General, & Admin.

(93.6)

(103.2)

(109.4)

(114.9)

6

Depreciation

(7.0)

(7.5)

(9.0)

(9.5)

7

EBIT

53.8

59.6

62.1

65.2

8

Less: Income Tax at 40%

(21.5)

(23.8)

(24.8)

(26.1)

9

Plus: Depreciation

7.0

7.5

9.0

9.5

10

Less: Capital Expenditures

(7.7)

(10.0)

(9.9)

(10.4)

11

Less: Increase in NWC

(6.3)

(8.6)

(5.6)

(4.9)

12

Free Cash Flow

25.3

24.6

30.8

33.3

a. Suppose Sora's revenue and free cash flow are expected to grow at a 4.9%

rate beyond year four. If Sora's weighted average cost of capital is 12.0%, what is the value of Sora stock based on this information?

b. Sora's cost of goods sold was assumed to be 67% of sales. If its cost of goods sold is actually 70% of sales, how would the estimate of the stock's value change?

c. Return to the assumptions of part (a) and suppose Sora can maintain its cost of goods sold at 67% of sales. However, the firm reduces its selling, general, and administrative expenses from 20% of sales to 16% of sales. What stock price would you estimate now? (Assume no other expenses, except taxes, are affected.)

d. Sora's net working capital needs were estimated to be 18% of sales (their current level in year zero). If Sora can reduce this requirement to 12% of sales starting in year 1, but all other assumptions are as in (a), what stock price do you estimate for Sora? (Hint: This change will have the largest impact on Sora's free cash flow in year 1.)

Answer 1

The answer is explained below: