Question

Quinton Johnston is evaluating TMI Manufacturing Company, Ltd., which is headquartered
in Taiwan. In 2008, when Johnston is performing his analysis, the company is unprofitable.
Furthermore, TMI pays no dividends on its common shares. Johnston decides
to value TMI Manufacturing by using his forecasts of FCFE. Johnston gathers the following
facts and assumptions:
• The company has 17.0 billion shares outstanding.
• Sales will be $5.5 billion in 2009, increasing at 28 percent annually for the next four
years (through 2013).
• Net income will be 32 percent of sales.
• Investment in fixed assets will be 35 percent of sales; investment in working capital will
be 6 percent of sales; depreciation will be 9 percent of sales.
• 20 percent of the net investment in assets will be financed with debt.
• Interest expenses will be only 2 percent of sales.
• The tax rate will be 10 percent. TMI Manufacturing’s beta is 2.1; the risk-free government
bond rate is 6.4 percent; the equity risk premium is 5.0 percent.
• At the end of 2013, Johnston projects TMI terminal stock value at 18 times earnings.
What is the value of one ordinary share of TMI Manufacturing Company?

Answer 1

Calculation of FCFE

      Amount in ($ billion)

Particulars	2009	2010	2011	2012	2013
Sales	5.5	7.04	9.01	11.53	14.76
Net Income @32% of sales	1.76	2.25	2.88	3.69	4.72
Add- Depreciation @9% of sales (only equity potion i.e., 80%)	0.40	0.51	0.65	0.83	1.06
less- Investment in fixed assets @35% of sales (only equity potion i.e., 80%)	(1.54)	(1.97)	(2.52)	(3.23)	(4.13)
less- Investment in working capital @6% of sales (only equity potion i.e., 80%)	(0.26)	(0.34)	(0.43)	(0.55)	(0.71)
FCFE	0.36	0.45	0.58	0.74	0.94

Calculation of cost of equity

K_E = risk free rate + beta of security * ( return of market - risk free return)

= risk free rate + equity risk premium

= 6.4 + 5.0

= 10.4%

Calculation of terminal value

Terminal value = 18 * net income in 2013

= 18 * 4.72

= $ 84.96 billion

Calculation of value of equity

Year	Free cah flow ($ billion)	PVIF @10.40 %	P.V
2009	0.36	0.906	0.326
2010	0.45	0.820	0.369
2011	0.58	0.743	0.431
2012	0.74	0.673	0.498
2013	0.94	0.610	0.573
2013 (Terminal value)	84.96	0.610	51.826
Value of equity	54.023

Value of equity = $ 54.023 billion

Value of one equity share = $54.023 billion / 17 billion shares

= $ 3.178

Hence, value of one ordinary share of TMC Manufacturing Company is $3.178