Question

Sora Industries has

60 million outstanding​ shares,

$ 120 million in​ debt,

$ 40 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​ 25%			​(13.5)	​(14.9)	​(15.5)	​(16.3)
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			33.433.4	33.633.6	40.140.1	43.143.1

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

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

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

a. Value of Sora’s Stock

V(3) = 33.3 / (10% - 5%) = 666

V(0) = 25.3/1.10 + 24.6/1.10² + (30.8 + 666)/1.10³ = 567

P(0) = (567 + 40 – 120)/60 = $8.11

Particulars	Years
	0	1	2	3	4	5
Earnings Forecast (in $000s)		8%	10%	6%	5%	5%
Sales	433.00	468.00	516.00	546.96	574.31	603.02
Cost of Goods Sold		(327.60)	(361.20)	(382.87)	(402.02)	(422.12)
Gross Profit		140.40	154.80	164.09	172.29	180.90
Selling, General and Administration Expenses		(93.60)	(103.20)	(109.39)	(114.86)	(120.60)
Depreciation		(7.00)	(7.50)	(9.00)	(9.45)	(9.92)
EBIT		39.80	44.10	45.70	47.98	50.38
Income Tax		(15.92)	(17.64)	(18.28)	(19.19)	(20.15)
Unlevered Net Income		23.88	26.46	27.42	28.79	30.23
Free Cash Flows (in $000s)
Depreciation		7.00	7.50	9.00	9.45	9.92
Capital Expenditures		(7.70)	(10.00)	(9.90)	(10.40)	(10.91)
Increase in Net Working Capital		(6.30)	(8.64)	(5.57)	(4.92)	(5.17)
Free Cash Flows		16.88	15.32	20.95	22.92	24.07

b. Free Cash Flow Changes-

Now V(3) = 458, V(0) = 388. Thus P(0) = $5.13.

Particulars	Years
	0	1	2	3	4	5
Earnings Forecast (in $000s)		8%	10%	6%	5%	5%
Sales	433.00	468.00	516.00	546.96	574.31	603.02
Cost of Goods Sold		(313.56)	(345.72)	(366.46)	(384.79)	(404.03)
Gross Profit		154.44	170.28	180.50	189.52	198.99
Selling, General and Administration Expenses		(74.88)	(82.56)	(87.51)	(91.89)	(96.48)
Depreciation		(7.00)	(7.50)	(9.00)	(9.45)	(9.92)
EBIT		72.56	80.22	83.99	88.18	92.59
Income Tax		(29.02)	(32.09)	(33.60)	(35.27)	(37.04)
Unlevered Net Income		43.54	48.13	50.39	52.91	55.55
Free Cash Flows (in $000s)
Depreciation		7.00	7.50	9.00	9.45	9.92
Capital Expenditures		(7.70)	(10.00)	(9.90)	(10.40)	(10.91)
Increase in Net Working Capital		(6.30)	(8.64)	(5.57)	(4.92)	(5.17)
Free Cash Flows		36.54	36.99	43.92	47.04	49.39

c. New Free Cash Flow-

Now V(3) = 941, V(0) = 804. Thus P(0) = $12.07.

d. Increase in NWC in Yr. 1 = 12% of Sales (1) - 18% of Sales (0)

Increase in NWC in later years = 12% x Change in Sales

Particulars	Years
	0	1	2	3	4	5
Earnings Forecast (in $000s)		8%	10%	6%	5%	5%
Sales	433.00	468.00	516.00	546.96	574.31	603.02
Cost of Goods Sold		(313.56)	(345.72)	(366.46)	(384.79)	(404.03)
Gross Profit		154.44	170.28	180.50	189.52	198.99
Selling, General and Administration Expenses		(93.60)	(103.20)	(109.39)	(114.86)	(120.60)
Depreciation		(7.00)	(7.50)	(9.00)	(9.45)	(9.92)
EBIT		53.84	59.58	62.11	65.21	68.47
Income Tax		(21.54)	(23.83)	(24.84)	(26.08)	(27.39)
Unlevered Net Income		32.30	35.75	37.27	39.13	41.08
Free Cash Flows (in $000s)
Depreciation		7.00	7.50	9.00	9.45	9.92
Capital Expenditures		(7.70)	(10.00)	(9.90)	(10.40)	(10.91)
Increase in Net Working Capital		21.78	(5.76)	(3.72)	(3.28)	(3.45)
Free Cash Flows		53.38	27.49	32.65	34.90	36.64

Thus New FCF:

Now V(3) = 698, V(0) = 620. Thus P(0) = $9.00.