Question

Sora Industries has

6161

million outstanding​ shares,

$ 122$122

million in​ debt,

$ 47$47

million 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			25.325.3	24.624.6	30.830.8	33.333.3

a. Suppose​ Sora's revenue and free cash flow are expected to grow at a

5.4 %5.4%

rate beyond year four. If​ Sora's weighted average cost of capital is

10.0 %10.0%​,

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

We know that,

Required a)

Firm value = $25.3/1.10 + 24.6 / (1.10)² + 30.8 / (1.10)³ + 33.3 / (1.10)⁴ + (33.33 * 1.054) / (0.10 - 0.054)(1.10)⁴

= 23 + 20.3 + 23.1 + 22.7 + 521.6

= $610.8 million

Value of Sora's stock = Value of the firm - Value of debt = $610.8 - $122 = $488.8 million

Required b)

Particulars	Year 1	Year 2	Year 3	Year 4
Sales	468.0	516.0	547.0	574.3
Cost of goods sold @67%	313.6	345.7	366.5	384.8
Cost of goods sold @70%	327.6	361.2	382.9	402.0
Increase in COGS	14.0	15.5	16.4	17.2
Less: Tax savings @40%	5.6	6.2	6.6	6.9
Decrease in Free cash flow	8.4	9.3	9.8	10.3
New Free cash flow	16.9	15.3	21.0	23.0

Firm value = $16.9/1.10 + 15.3 / (1.10)² + 21.0/ (1.10)³ + 23.0 / (1.10)⁴ + (23.0 * 1.054) / (0.10 - 0.054)(1.10)⁴

= 15.4 + 12.6 + 15.8 + 15.7 + 359.9

= $419.4 million

Value of Sora's stock = Value of the firm - Value of debt = $419.4 - $122 = $297.4 million

Required c)

Particulars	Year 1	Year 2	Year 3	Year 4
Sales	468.0	516.0	547.0	574.3
S G & A Expense @ 20%	93.6	103.2	109.4	114.9
S G & A Expense @ 16%	74.9	82.6	87.5	91.9
Decrease in expenses	18.7	20.6	21.9	23.0
Less: Tax @40%	7.5	8.3	8.8	9.2
Increase in Free cash flow	11.2	12.4	13.1	13.8
New Free cash flow	36.5	37.0	43.9	47.1

Firm value = $36.5/1.10 + 37.0 / (1.10)² + 43.9/ (1.10)³ + 47.1 / (1.10)⁴ + (47.1 * 1.054) / (0.10 - 0.054)(1.10)⁴

= 33.2 + 30.6 + 33.0 + 32.2 + 737.1

= $866.0 million

Value of Sora's stock = Value of the firm - Value of debt = $866.0 - $122 = $744.0 million

Required d)

Particulars	Year 0	Year 1	Year 2	Year 3	Year 4
Sales	433	468.0	516.0	547.0	574.3
Increase in sales vs prior year		35.0	48.0	31.0	27.3
Increase in NWC @ 18%		6.3	8.6	5.6	4.9
Increase in NWC @ 12%		4.2	5.8	3.7	3.3
Increase in Free cash flow		2.1	2.9	1.9	1.6
New Free cash flow		27.4	27.5	32.7	34.9

Firm value = $27.4 / 1.10 + 27.5 / (1.10)² + 32.7 / (1.10)³ + 34.9 / (1.10)⁴ + (34.9 * 1.054) / (0.10 - 0.054)(1.10)⁴

= 24.9 + 22.7 + 24.6 + 23.8 + 546.2

= $642.2 million

Value of Sora's stock = Value of the firm - Value of debt = $642.2 - $122.0 = $520.2 million

Feel free to ask for any clarification, if required. Kindly provide feedback by thumbs up. It would be highly appreciated. Thank You.