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AFC Ltd Sales growth 10% Current assets/Sales 15% Current liabilities/Sales 8% Net fixed assets/Sales 77% Costs...

AFC Ltd
Sales growth 10%
Current assets/Sales 15%
Current liabilities/Sales 8%
Net fixed assets/Sales 77%
Costs of goods sold/Sales 70%
Depreciation rate 10%
Interest rate on debt 5%
Interest paid on cash and marketable securities 4%
Tax rate 30%
Dividend payout ratio 40%
Year 0 1 2 3 4 5
Income statement
Sales 1000 1100 1210 1331 1464 1611
Costs of goods sold -700 -770 -847 -932 -1025 -1127
EBITDA 300 330 363 399 439 483
Interest payments on debt -16 -16 -16 -16 -16 -16
Interest earned on cash and marketable securities 3 3 3 3 3 3
Depreciation -100 -107 -125 -146 -170 -198
Profit before tax 187 210 225 240 256 273
Taxes -56 -63 -68 -72 -77 -82
Profit after tax 131 147 158 168 179 191
Dividends -52 -59 -63 -67 -72 -76
Retained earnings 79 88 95 101 108 114
Balance sheet
Cash and marketable securities 80 84 86 86 82 73
Current assets 150 165 182 200 220 242
Fixed assets
     At cost 1070 1254 1464 1704 1977 2287
     Depreciation -300 -407 -532 -679 -849 -1047
     Net fixed assets 770 847 932 1025 1127 1240
Total assets 1000 1096 1200 1310 1429 1555
Current liabilities 80 88 97 106 117 129
Debt 320 320 320 320 320 320
Stock 450 450 450 450 450 450
Accumulated retained earnings 150 238 333 434 541 656
Total liabilities and equity 1000 1096 1200 1310 1429 1555
Year 0 1 2 3 4 5
Free cash flow calculation
Profit after tax 147 158 168 179 191
Add back depreciation 107 125 146 170 198
Subtract increase in current assets -15 -17 -18 -20 -22
Add back increase in current liabilities 8 9 10 11 12
Subtract increase in fixed assets at cost -184 -210 -240 -273 -310
Add back after-tax interest on debt 11 11 11 11 11
Subtract after-tax interest on cash and mkt. securities -2 -2 -2 -2 -2
Free cash flow 72 74 75 76 77
Valuing the firm
Weighted average cost of capital 12%
Long-term free cash flow growth rate 5%
Number of Shares 1000

Q1.

Using the information supplied calculate:

  1. Enterprise Value
  2. Equity Value
  3. Price per share

If the current share price is $0.55 per share what recommendation would you make to an investor who was interested in purchasing this stock?

Q2.

Given the following information about potential values for the long term growth rate:

Long Term Growth Possibilities

Rate

Probability

Best

5%

0.2

Likley

3.50%

0.5

Worst

2%

0.3

Revise your estimate of the price per share.

How would you explain the difference in the price estimates to an investor?

Q3.

The P/E multiples for three comparable companies are given below:

Comparables

A

B

C

P/E

7.14

5.73

7.91

Use these multiples and the information from question one to estimate the share price.

Explain the differences in the estimates of share price that you have made in this section?

Could you please help me with this problem? Thank you！

Solutions

Expert Solution

Income Statement
Year 0 1 2 3 4 5
Sales (Previous year sales*110%) 1,000 1,100 1,210 1,331 1,464 1,611
Costs of goods sold (Sales*70%) -700 -770 -847 -932 -1,025 -1,127
EBITDA (Sales-COGS) 300 330 363 399 439 483
Interest payment on debt (320*5%) -16 -16 -16 -16 -16 -16
Interest earned on cash & mkt securities (Cash & securities*4%) 3 3 3 3 3 3
Depreciation -100 -107 -125 -146 -170 -198
Profit before tax 187 210 225 241 257 272
Taxes @ 30% -56 -63 -68 -72 -77 -82
Profit after tax 131 147 158 169 180 190
Dividends @ 40% -52 -59 -63 -67 -72 -76
Retained earnings (PAT-dividends) 79 88 95 101 108 114
Balance sheet
Year 0 1 2 3 4 5
Cash and marketable securities 80 84 86 86 82 73
Current assets 150 165 182 200 220 242
Fixed assets
At cost 1,070 1,254 1,464 1,704 1,977 2,287
Depreciation -300 -407 -532 -678 -848 -1,046
Net fixed assets 770 847 932 1,025 1,127 1,240
Total assets 1,000 1,096 1,199 1,311 1,429 1,555
Current Liabilities 80 88 96 106 117 129
Debt 320 320 320 320 320 320
Stock 450 450 450 450 450 450
Accumulated retained earnings 150 238 333 434 542 656
Total liabilities & equity 1,000 1,096 1,199 1,311 1,429 1,555
Free cash flow calculation
Year 1 2 3 4 5
Profit after tax 147 158 169 180 190
Add back depreciation 107 125 146 170 198
Subtract increase in current assets -15 -17 -18 -20 -22
Add back increase in current liabilities 8 9 10 11 12
Subtract increase in fixed assets at cost -184 -210 -240 -273 -310
Add back after-tax interest on debt 11 11 11 11 11
Subtract after-tax interest on cash & mkt securities -2 -2 -2 -2 -2
Free cash flow 72 74 75 76 77

Part 1a)

Computation of enterprise value using free cashflow (FCF) model:

Terminal free cashflow = cashflow at year 5*(1+Long-term free cash flow growth rate)/(WACC-Long-term free cash flow growth rate) = 77*(1+0.05)/(0.12-0.05) = 77*1.05/0.07 = 1,155

Enterprise value = {FCF in year 1/(1+WACC)}+{FCF in year 2/[(1+WACC)^2]}+{FCF in year 3/[(1+WACC)^3]}+{FCF in year 4/[(1+WACC)^4]}+{(FCF in year 5+Terminal free cashflow)/[(1+WACC)^5]} = {72/(1+0.12)}+{74/[(1+0.12)^2]}+{75/[(1+0.12)^3]}+{76/[(1+0.12)^4]}+{(77+1,155)/[(1+0.12)^5]} = {72/1.12}+{74/(1.12^2)}+{75/(1.12^3)}+{76/(1.12^4)}+{1,232/(1.12^5)} = 64.2857+(74/1.2544)+(75/1.404928)+(76/1.57351936)+(1,232/1.762341683) = 64.2857+58.9923+53.3835+48.2994+699.0699 = 924.0308

Enterprise value = 924.0308

Part 1b)

Equity value = Enterprise value - Debt = 924.0308 - 320 = 604.0308

Part 1c)

Price per share = Equity value/number of shares = 604.0308/1000 =0.604 per share

Part 1d)

If current price per share is $0.55, the share is undervalued hence recommended to purchase the share.

Part 2)

Long term growth rate = Possibility*rate = (5%*0.2)+(3.5%*0.5)+(2%*0.3) = 1%+1.75%+0.6% = 3.35%

Terminal free cashflow = cashflow at year 5*(1+New Long-term free cash flow growth rate)/(WACC - New Long-term free cash flow growth rate) = 77*(1+0.0335)/(0.12-0.0335) = 77*1.0335/0.0865 = 920

Enterprise value = {FCF in year 1/(1+WACC)}+{FCF in year 2/[(1+WACC)^2]}+{FCF in year 3/[(1+WACC)^3]}+{FCF in year 4/[(1+WACC)^4]}+{(FCF in year 5+Terminal free cashflow)/[(1+WACC)^5]} = {72/(1+0.12)}+{74/[(1+0.12)^2]}+{75/[(1+0.12)^3]}+{76/[(1+0.12)^4]}+{(77+920)/[(1+0.12)^5]} = {72/1.12}+{74/(1.12^2)}+{75/(1.12^3)}+{76/(1.12^4)}+{997/(1.12^5)} = 64.2857+(74/1.2544)+(75/1.404928)+(76/1.57351936)+(997/1.762341683) = 64.2857+58.9923+53.3835+48.2994+565.7246 = 790.6855

Equity value = Enterprise value - Debt = 790.6855 - 320 = 470.6855

Price per share = Equity value/number of shares = 470.6855/1000 =0.47 per share

Since the expected growth rate reduced, value of future cashflow fall, value of firm will fall & share price also fall. Earlier growth rate is 5% now 3.35%

Part 3)

Average P/E ratio = (7.14+5.73+7.91)/3 = 6.93

Earnings per share (EPS) = Profit after tax/Number of shares = 131/1000 = 0.131

Market price per share = P/E ratio * EPS = 6.93*0.131 = 0.9078 per share

Since without looking into firm specific earning capacity, based on comparable P/E ratio investor can make investment. Since this price is too high as compared to price computated based on Free cash flow model. Without looking into other factors, 6.93 times of firm EPS investor can ready to invest.

jeff jeffy answered 1 year ago
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