Question

Assume that today is December 31,2018 and that the following information applies to Vermeil Airlines:

• After-tax operating income [EBIT(1 – T)] for 2019 is expected to be $518 million.
• The depreciation expense is expected to be $122 million.
• The capital expenditures are expected to be $241 million.
• No change is expected in net operating working capital.
• The free cash flow is expected to grow at a constant rate of 2.0% per year.
• The required return on equity is 12.4%.
• The WACC is 10.3%.
• The market value of the company’s debt is $2.4 billion.
• 207 million shares of stock are outstanding.

Using the corporate valuation model approach, what should be the company’s stock price today?

Please extend answer to 4 decimal places.

Answer 1

Step-1, Free Cash Flow (FCF)

Free Cash Flow (FCF) = Net Operating Profit After Tax(NOPAT) + Depreciation Expenses - Capital Expenditures – Changes in Net Working Capital

=EBIT(1 – Tax Rate) + Depreciation - Capital Expenditures – Changes in Net Working Capital

= $518 Million + $122 Million - $241 Million – $0 Million

= $399 Million

Step-2, Total Firm Value

Weighted Average Cost of Capital (WACC) = 10.30%

Growth Rate (g) = 2.00% per year

Therefore, the Total Firm Value = FCF / (WACC – g)

= $399 Million / (0.1030 – 0.02)

= $399 Million / 0.0830

= $4,807.23 Million

Step-3, Value of Common Equity

Value of Common Equity = Total Firm Value - Market Value of Debt

= $4,807.23 Million - $2,400 Million

= $2,407.23 Million

Step-4, Stock price today

The Stock price today = Value of Common Equity / Number of shares of common stock outstanding

= $2,407.23 Million / 207 Million common shares outstanding

= $11.6291 per share

“Hence, the company's intrinsic stock price today will be $11.6291 per share”