Question

Full Boat Manufacturing has projected sales of $122.5 million next year. Costs are expected to be $72.8 million and net investment is expected to be $14.4 million. Each of these values is expected to grow at 12 percent the following year, with the growth rate declining by 2 percent per year until the growth rate reaches 4 percent, where it is expected to remain indefinitely. There are 6.2 million shares of stock outstanding and investors require a return of 11 percent return on the company’s stock. The corporate tax rate is 25 percent.

a. What is your estimate of the current stock price? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

b. Suppose instead that you estimate the terminal value of the company using a PE multiple. The industry PE multiple is 11. What is your new estimate of the company’s stock price?

Answer 1

a. Current Stock Price

Step 1: Calculation of yearly free cash-flows:

	Year 1
Sales	122,500,000	Given in question
Costs	72,800,000	Given in question
Profit Before Tax	49,700,000	Sales-Costs
Profit After Tax	37,275,000	Profit Before Tax*(100%-25%)
Net Investment	14,400,000	Given in question
Net Cash flows after tax	22,875,000	Profit After tax + Net Investment

Step 2: Calculation of Present value of free cash-flows:

Workings:

Step 3: Calculation of Stock Price:

Stock Price = Present Value of free cash flows / number of shares outstanding = $385,664,602/6,200,000 = $62.20

The current stock price is $62.20.

b. Current Stock Price with Terminal Value using a PE Multiple:

When terminal value is using a PE multiple, then the terminal value will equal Free cash-flows at terminal year multiplied with the PE multiple. Thus, in this question, free cash flow of year 6 is $33,553,264. Industry PE Multiple is 11. Thus, terminal value = $33,553,264 * 11 = $369,085,901.

Except for terminal value, all other variables will remain the same as (a) above.

Workings:

Stock Price = Present Value of free cash flows / number of shares outstanding = $316,471,529 / 6,200,000 = $51.04

The revised current stock price is $51.04.