Question

1) ABC Inc. will pay its first annual dividend of $3 one year from today. In the second year, the dividend will be $3.5. Dividends for year 3 and year 4 will be $4 and $5, respectively. After that, the dividends will decline at a constant rate of 3% per year till year 8. Thereafter, the dividends will grow at a constant rate of 5% per year forever. If the discount rate used is 10%, what is the stock price of ABC Inc. today?

2) Sora Industries has $63 million outstanding shares, $129 million in debt, $40 million in cash, and the following projected free cash flow for the next four years:

Year 0 1 2 3 4
Earning & FCF Forecast
($millions)
Sales 433 468 516 547 574.3
Growth vs. Prior Year 8.1% 10.3% 6.0% 5.0%
Cost of Goods Sold (313.6) (345.7) (366.5) (384.8)
Gross Profit 154.4 170.3 180.5 189.5
Selling, General & Admin. (93.6) (103.2) (109.4) (114.9)
Depreciation (7.0) (7.5) (9.0) (9.5)
EBIT 53.8 59.6 62.1 65.2

a) Suppose Sora's revenue and free cash flow are expected to grow at a 5.7 % rate beyond
year 4. If Sora's weighted average cost of capital is 14.0 %, what is the value of Sora's 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?
Less: Income tax at 40% (21.5) (23.8) (24.8) (26.1)
Plus: Depreciation 7 7.5 9 9.5
Less: Capital Expenditures (7.7) (10.0) (9.9) (10.4)
Less: Increases in NWC (6.3) (8.6) (5.6) (4.9)
Free Cash Flow 25.3 24.6 30.8 33.3

Answer 1

1]

stock price today = present value of next 8 years dividend + present value of terminal value at end of 8 years

Terminal value at end of 8 years = Year 8 dividend * (1 + growth rate after 8 years) / (required return - growth rate after 8 years)

Present value = future value / (1 + discount rate)^{number of years}

The stock price today = $65.48