Innovation Incorporated had operating income before interest and taxes in 2018 of $350 million. The firm...

Innovation Incorporated had operating income before interest and taxes in 2018 of $350 million. The firm was expected to generate this level of operating income indefinitely. The firm had depreciation expense of $25 million that same year. Capital spending totaled $40 million during 2018. At the end of 2017 and 2018, working capital totaled $90 and $70 million, respectively. The firm’s combined marginal state, local, and federal tax rate was 30% and its debt outstanding had a market value of $0.50 billion. The 10-year Treasury bond rate is 3% and the borrowing rate for companies exhibiting levels of creditworthiness similar to Innovation, Inc. is 8%. The historical risk premium for stocks over the risk-free rate of return is 4.5%. No Growth’s beta was estimated to be 1.2. The firm had 3 million common shares outstanding at the end of 2018. Innovation’s target debt to total capital ratio is 40%.

Estimate free cash flow to the firm in 2018.
Estimate the firm’s cost of capital.
Estimate the value of the firm (i.e., includes the value of equity and debt) at the end of 2018, assuming that it will generate the value of free cash flow estimated in (a) indefinitely.
Estimate the value of the equity of the firm at the end of 2018.

Estimate the value per share at the end of 2018.

Expert Solution

a]	EBIT	$ 350.000	million
	+Depreciation	$ 25.000	million
	-Taxes [350*40%]	$ 140.000	million
	-Capital expenditure	$ 40.000	million
	-Change in NWC [70-90]	$ (20.000)	million
	FCF for 2018	$ 215.000	million
b]	After tax cost of debt = 8%*(1-40%) =	4.80%
	Cost of equity per CAPM = 3%+1.2*4.5% =	8.40%
	WACC = 4.80%40%+8.40%60% =	6.96%
c]	Value of the firm = 215/6.96% =	$ 3,089.080	million
d]	Value of the firm	$ 3,089.080	million
	Less: Value of debt	$ 500.000	million
	Value of equity	$ 2,589.080	million
e]	Number of shares	3	million
	Value per share	$ 863.03

jeff jeffy answered 2 years ago

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