Question

You are valuing Soda City Inc. It has $150 million of debt, $70 million of cash, and 200 million shares outstanding. You estimate its cost of capital is 8.0%. You forecast that it will generate revenues of $740 million and $760 million over the next two years, after which it will grow at a stable rate in perpetuity. Projected operating profit margin is 40%, tax rate is 20%, reinvestment rate is 60%, and terminal EV/FCFF exit multiple at the end of year 2 is 8. What is your estimate of its share price? Round to one decimal place.

Answer 1

We will be using exit multiple method to calculate the share price of Soda City. Share price of a company is equal to the present value of cash flows it can generate in future.

For this first we will find out the free cash flow that the firm will generate in first two years. As the revenue is 740 million and 760 million in first two years respectively and the operating profit margin is 40% we will get operating profit of 296 million and 304 million in first two years. Then we will subtract tax at 20% rate from this to find Net Operating Profit after Tax (NOPAT). Now we know that reinvestment is of 60%, so we will multiply the NOPAT by (1- Reinvestment rate) to find the FCFF of the firm as reinvestment is the investment in capex and working capital and the remaining is what has been left for the firm. Now as we do not know the depreciation expense we will assume it to be 0. Kindly refer to below table.

Revenue	740	760
OP	296	304
Tax	-59.2	-60.8
NOPAT	236.8	243.2
FCFF	94.72	97.28

Now our exit multiple is EV/FCFF which is equal to 8. We will use this to calculate the terminal value of the firm which will come out to be USD778.2 million (97.2*8).

Now we will be finding out the present value of the cash flows by using cost of capital of 8% by using the following formula.

where,

CF= Cash flow

COC= Cost of Capital

n= Number of years

We will be finding out the present value of terminal value at Year 2.

PV of year 1 cash flow would be = 94.7/(1+8%)^1= USD87.7 million

Similarly, the present value of Year 2 cash flow and terminal value will come out to be USD83.4 and USD667.2 million respectively.

We will now calculate the Enterprise Value of the firm by adding the present value of these cash flows

= 87.7+83.4+667.2

Enterprise Value =USD838.3 million

Now we will find the Equity Val;ue by subtracting the debt of USD150 million and adding cash of USD70 million to Enterprise Value

This will give us Equity Value of USD758.3 million for Soda City.

As the company has 200 million shares outstanding we will find the share price of its each share by dividing the equity value by total number of outstanding shares.

=758.3/200

Which will give us a Share price of USD3.8