Question

Calculate what you think the share price for company X should be given the following information and modelling firm value as a perpetuity with growth:

Cash Flow From Operations= 15,500m

Capital Expenditure= 4,600m

Interest Expense= 950m

Corporate Tax= 30%

Growth rate = 2% every year

Cash on Balance Sheet = 6,200m

Number of Shares = 5,000m

Total Debt = 8,000m

Total Equity= 90,000m

Cost of Equity re= 9.5%

Cost of Debt rd = 4%

If the share currently costs $12 in the market, what action would you take?

must show all work step by step

Answer 1

first we calculate weighted average cost of capital (WACC).

WACC = weight of debt*[cost of debt*(1-tax rate)] + weight of equity*cost of equity

weight of debt = Total debt/Total capital; and weight of equity = Total equity/Total capital

Total capital = Total debt + Total equity = 8,000 + 90,000 = 98,000

weight of debt = 8,000/98,000 = 0.08

weight of equity = 90,000/98,000 = 0.92

WACC = 0.08*[4%*(1-0.30)] + 0.92*9.5% = 0.08*(4%*0.70) + 8.74% = 0.08*2.8% + 8.74% = 0.224% + 8.74% = 8.96%

now we calculate free cash flow (FCF).

FCF = Cash Flow From Operations - Capital Expenditure = 15,500 - 4,600 = 10,900

Firm value = FCF*(1+Growth rate)/(WACC - Growth rate)

Firm value = 10,900*(1+0.02)/(0.0896 - 0.02) = (10,900*1.02)/0.0696 = 11,118/0.0696 = 159,741.38

Equity value = Firm value + cash - Total debt = 159,741.38 + 6,200 - 8,000 = 157,941.38

Share price = Equity value/no. of shares = 157,941.38/5,000 = 31.59

If the share currently costs $12 in the market then you should buy the shares because intrinsic value per share of $31.59 is higher market price per share of $12.