Question

Fauji Fertilizer Corporation expects to generate following free cashflows in coming 5 years.

Year 1 2 3 4 5
FCF (Rs. Million) 51 70 77 72 80

After this time period, the free cashflows will grow constantly at 3% per year. The firm’s cost of capital is 13%. Using the discounted free cashflow model, calculate the following.

a. What is the enterprise value of Fauji Fertilizer Ltd? (2.5 marks)
b. If Fauji Fertilizer have access cash of Rs. 32 million, debt of Rs. 280 million, and the 40 million shares outstanding and trading in the market, what should be the expected share price of Fauji Fertilizer? (2.5 marks)
c. Suppose that the stocks of Fauji Fertilizer are being sold in the market at Rs. 12 per share. Will you buy that stock? why or why not? (1 mark)

Answer 1

Given

Year	1	2	3	4	5
FCF (Rs. Million)	51	70	77	72	80

Cost of capital = 13%

free cashflows will grow after 5th year (g) = 3%

a) What is the enterprise value of Fauji Fertilizer Ltd? Using the discounted free cashflow model

To calculate Enterprise value,

we have to, sum all discounted (5years) free cash flows @ 13% (given) + Discounted Terminal value

i)  normal eqution to get Future value (FV) = Present Value (PV) * ( 1 + i)ⁿ

now

now we have to discount all free cashflows of coming 5 years

Given FCF₁ = 51, FCF₂ = 70_, FCF₃  =77_, FCF4  = 72, FCF₅ =80

= FCF₁ / ( 1+i)ⁿ + FCF₂ / ( 1+i)ⁿ + FCF₃ / ( 1+i)ⁿ + FCF₄ / ( 1+i)ⁿ​​​​​​​ + FCF₅ / ( 1+i)ⁿ​​​​​​​

= 51 / (1+0.13)¹ + 70 / (1+0.13)²​​​​​​​+ 77 / (1+0.13)³ ​​​​​​​+ 72 / (1+0.13)⁴ ​​​​​​​+ 80 / (1+0.13)⁵

  = 240.9023

ii) Terminal value

  Terminal value = (FCF * ( 1 + g)) / (d - g)

FCF = Free cash flows for last forcaste period

g = Terminal growth rate

d = discount rate

Terminal value = (80* (1+.03)) / (0.13 -.03)

= 82.4 / 0.10

= 824

Pv of Terminal value = 824 / (1 + 0.13)⁵

   = 447.2672

Enterprise value of Fauji Fertilizer Ltd = Pv of free cash flows + Pv of Terminal value

= 240.9023 + 447.2672

  = 688.1695 million

b)  expected share price of Fauji Fertilize ?

    Expected share price = (Enterprise value - Debt + cash) / no. of share outstanding

=(688.1695 - 280 + 40) / 40

= 448.1698 / 40

= 11.20

c) The Expected share price we have calculated above (b) is 11.20

but the market price is 12.

It is trading more than the expected share price so, no buy

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