Question

Sora Industries has 66 million outstanding​ shares, $124 million in​ debt, $50million 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 5.7%rate beyond year four. If​ Sora's weighted average cost of capital is 14.0%​,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

a. Value of Sora stock

To calculate the value of the stock, we need to first calculate the terminal value. Then, we need to calculate the present values of the projected free cash flows and the terminal. By adding the present value, we will get the enterprise value of the stock. After deducting debt and adding cash from enterprise value, we will get the market capitalization of the stock. Dividing the market cap by outstanding shares will give the value of the stock.

Calculation is as follows:

Formulas:

b. If cost of goods sold is actually​ 70% of​ sales

We need to just change the assumption of cost of goods sold as a % of sales from 67% to 70%

Formulas:

c. If the firm reduces its​ selling, general, and administrative expenses from​ 20% of sales to​ 16% of sales
We need to just change the assumption of selling, general, and administrative expenses as a % of sales from 20% to 16%

Formulas:

d.

If net working capital reduces from 18% of sales to 12% year 1 onwards. We can do this by simply changing the assumption we made previously. NWC in year 0 will remain the same.

Formulas: