Question

Cell Phone Inc. is a private cellular firm that reported net income of $5 million in the current financial year. The firm has borrowed $10 million at a rate of 15%, on which it reported interest expenses of $1.5 million in the current financial year. Cell Phone’s debt has an estimated current market value of $8.5 million. The firm has depreciation of $0.1 million for the current year, and capital expenditures equal to 200% of depreciation. The firm’s sales and capital expenditures are expected to grow at 5% annually during the next five years, while depreciation and interest expenses will remain constant. The firm has estimated that COGS (excluding depreciation) over Sales is 35% and that SG&A/Sales is 15%. The following information was also obtained from peer publicly traded firms:

Firm Asset Beta P/E M/B (Equity)

A 0.65 8.2 1.6

B 0.70 9.5 1.3

C 0.55 7.3 0.9

D 0.63 10.5 1.2

E 0.58 15.2 1.4

The firm’s book value of equity is $7.5 million and the firm’s owners hold 750,000 shares. The yield on 10 year Treasuries is 6.5% and the historic market risk premium is assumed to be 5.5%. Assuming that there is no working capital requirement and a constant growth rate of FCFF of 4% beyond the forecast period of five years, estimate a range for the firm’s intrinsic value per share at the end of the current year (tax rate = 50%).

Answer 1

AS given

Net Income 5000000

Debt 10000000 @ 15% interest and it is estimated to be constant that is 1500000

depreciation is estimated to be constant it remains to be 0.1 million

EBIT calculation

Profit after tax(net income)+interest income+tax paid

therefore 5000000+1500000+5000000= 11500000

tax rate is 50% so Earnings before tax would be 10000000( 5milllion tax+5 million net income)

Free cash flow o firm= EBIT Adjusted Tax+ Depreciation-CAPEX-change in working capital

FCFF TERMINAL = 5TH YEAR FCFF*(+4%)

Ebit adjusted tax = EBIT*(1-T)

CAPEX = 5% GROWTH FROM Current year

NOW FINDING DISCOUNT RATE (WACC)

Cost of equity = RISF FREE RATE +(RISK PREMIUN * BETA)

FINDING BETA:

GIVEN ASSET BETAS (Unlevered beta) IN THE QUESTION

TAKE AVERAGE BETA WHICH IS 0.62

now change asset beta to equity beta( levered beta)

by applying formula

asset beta*(1+(1-tax)*(DEBT/EQUITY)

Debt =10000000 Equirty= 7500000 Tax=50%

This gives you EQUITY BETA WHICH IS 1.03

Cost of eqity = 6.5%+(5.5%*1.03)

Risk free rate = 6.5% Risk premium= 5.5%

COST OF DEBT= 15% (inyerest rate paying om ddebt)

threfore

WACC(weighted average cost of capital)= weight of equity * cost of equity+ weight of debt* cost of debt

weight of equity = equity / equuity+debt

weight of debt = debt/ equity+debt

so by above formula we get wacc to be 13.80%

so the WACC would be the dicount rate at which we discount FCFF

NOW Calculating ENTERPRISE VALUE (NPV IN TABLE BELOW)

this is just the clculation of NPV from FCFF

=5927500/(1+13.8%)+6218875/*(1+13.8%)^2+6524818.75/(1+13.8%)^3...................................

here pv is c/(1+r)^n

TERMINAL PV= C/R=

by summing up all presxent values we get npv which is enterprse value =72368345.67

EQUITY VALUE= ENTERPROSE VALUE - DEBT(MARKET VALUE) = 63868345.67

INTRENSIC VALUE = EQUITY VALUE NO OF SHARES