Question

Sora Industries has 66 million outstanding shares, $124 million in debt, $60 million in cash, and the following projected free cash flow for the next four years:

Year    0 1    2    3    4 Earning & FCF Forecast ($millions)

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%

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: Increases in NWC (6.3) (8.6) (5.6) (4.9)

12 Free Cash Flow    25.3 24.6 30.8 33.3

a. Suppose Sora's revenue and free cash flow are expected to grow at a 3.1% rate beyond year 4. If Sora's weighted average cost of capital is 9.0%, what is the value of Sora's 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. Let's return to the assumptions of part (a) and suppose Sora can maintain its cost of goods sold at 67% of sales. However, now suppose Sora 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 (which is their current level in year 0). If Sora can reduce this requirement to 12% of sales starting in year 1, but all other assumptions remain as in part (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.)

I have provided all the info for this question. Went by the example unable to work the problem. I have provided the chart 1-12 please assist me in working this problem, its a 4-part question.

Answer 1

A.

We will be using the MULTIPLE GROWTH RATE FCFE model to calculate the stock price.

Since we do not have info on the debt to be repaid, we will have to assume net debt is equal to debt outstanding.

WACC = 9%

FCFF₁ = 25.3. PV discounting at WACC = 23.21

FCFF₂ = 24.6 PV discounting at WACC = 20.7

FCFF₃ = 30.8 PV discounting at WACC = 23.8

FCFF₄ = 33.3 PV discounting at WACC = 23.6

Applying perpetual growth rate for the 5th year onwards,

Long term growth rate (g) = 3.1%

FCFF = FCFF₄ * (1+g)/(WACC - g) = 33.3*(1+0.031)/(0.09-0.031) = 581.9

PV discounting at WACC = 499.6

Total FCFF = SUMMATION OF ALL THE FCFFs

= 590.9 = approx. 591 million

Calculate FCFE,

FCFE = FCFF - (Interest * 1-tax) + net debt

No info on interest given, hence assumed to be 0.

FCFE = FCFF + Net debt

= 591 + 124 = 715 million.

Stock price = FCFE /Number of shares outstanding = 715/66

= $10.84 per share.

B., C. And D.

For each of the remaining parts of the question, we simply need to modify the concerned figures.

Example, for part B, we need to increase the COGS and increase it to be 70% throughout each year. Accordingly, the EBIT as well as the income tax at 40% figure would change. Hence there will be a change in the FCFFs for each year. Ultimately the stock price would decrease.

Similarly for part C, since SG&A is reducing from 20% to 16%,EBIT and tax at 40% figure would change. In this case, the stock price will increase.

For part D, since net working capital is directly impacting the calculation of FCFF and eventually FCFE this reduction from 18% to 12% will have the biggest impact on the stock price.

The calculations for the three parts are the same as shown in part A. Just the input figures will have to modified as per question and the revised FCFFs and FCFEs have to derived to get the stock prices in each case.

Hope this helps.