Question

Sora Industries has 63 million outstanding shares, $ 130 million in debt, $ 56 million in cash, and the following projected free cash flow for the next four years LOADING... : a. Suppose Sora's revenue and free cash flow are expected to grow at a 4.9 % rate beyond year 4. If Sora's weighted average cost of capital is 10.0 % , 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? c. Let's return to the assumptions of part (a ) and suppose Sora can maintain its cost of goods sold at 67% of sales. However, now suppose Sora 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 (which is their current level in year 0). If Sora can reduce this requirement to 12% of sales starting in year 1, but all other assumptions remain as in part (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.) a. Suppose Sora's revenue and free cash flow are expected to grow at a 4.9 % rate beyond year 4. If Sora's weighted average cost of capital is 10.0 % , what is the value of Sora's stock based on this information?

Earnings & 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: Increases in NWC

(6.3)

(8.6)

(5.6)

(4.9)

12

Free Cash Flow

25.3

24.6

30.8

33.3

Answer 1

Sol a: Value of Sora's Stock based on the information that growth in revenues and FCF is 4.90% after Year 4

WACC is 10%; Free Cash Flow = $ 35.0 mn. We would use the formula = [FCF /(WACC-Growth)]

=[35.0 / (10% - 4.9%)]0 Solving this equation we will get $ 686.27 mn as Value of Sora's Stock

The Working for Sol (a) is as under:-

	Year 5 for Sol a
Sales	602.4
Growth vs Prior Year	4.9%
COGS	-403.6
Gross Profit	198.8
SGA	-120.5
Depreciation	-10.0
EBIT	68.4
Tax @ 40%	-27.3
Plus Dep	10.0
Less Capex	-10.9
Less Inc in NWC	-5.1
Free Cash Flow	35.0

Sol b: Value of Sora's Stock based on the information that growth in revenues after Year 4 of 4.90%

WACC is 10%; Free Cash Flow = $ 24.1 mn. We would use the formula = [FCF /(WACC-Growth)]

=[24.1 / (10% - 4.9%)] Solving this equation we will get $ 472.55 mn as Value of Sora's Stock

We would use the same Year 5 estimates just change the value of COGS to -421.7 from earlier -403.6. The effect on FCF was drop from 35.0 to 24.1 resulting in huge decline in Stock Value.

Sol c: Value of Sora's Stock based on the information that growth in revenues after Year 4 of 4.9%

With change in SGA from 20% of Sales to 16% of Sales the FCF has increased to 49.4 from Sol a 35.0

WACC is 10%; Free Cash Flow = $ 49.4 mn. We would use the formula = [FCF /(WACC-Growth)]

=[49.4 / (10% - 4.9%)] Solving this equation we will get $ 968.63 mn as Value of Sora's Stock

Sol d: Value of Sora's Stock based on the information that growth in revenues after Year 4 of 4.9%

With change in NWC need changed from 18% of Sales to 12% of Sales the FCF has increased to 36.7 from Sol a 35.0

WACC is 10%; Free Cash Flow = $ 36.7 mn. We would use the formula = [FCF /(WACC-Growth)]

=[36.7 / (10% - 4.9%)] Solving this equation we will get $ 719.61 mn as Value of Sora's Stock