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.

Hint：First, compute projected FCFF for years 1 and 2 using revenues, operating profit margin, tax rate, and reinvestment rate. Then compute terminal value using the exit multiple method, discount all FCFFs and TV to find EV, finally walk the bridge to the stock price.

Answer 1

Given for Soda City Inc.

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

So, EBIT in year 1 = Operating profit margin*revenue = 40% of 740 = $296 million

FCFF in year 1 = EBIT*(1-t)*(1-reinvestment rate) = 296*(1-0.20)*(1-0.6) = $94.72 million

Simmilarly EBIT for year 2 = 40% of 760 = $304 million

FCFF in year 2 = 304*(1-0.2)*(1-0.6) = $97.28 million

Company's cost of capital Kc = 8.00%

terminal exit value for this company is 8

So, terminal value of the company = 8*97.28 = $778.24 million

So, enterprise value is PV of FCFF and TV discounted at Kc

So, EV0 = FCFF1/(1+Kc) + FCFF2/(1+Kc)^2 + TV/(1+Kc)^2

EV0 = 94.72/1.08 + 97.28/1.08^2 + 778.24/1.08^2 = $838.32 million

Value of equity is calculated as:

Value of equity = Enterprise value - Debt + cash = 838.32 - 150 + 70 = $758.32 million

Thus market value of equity = $758.32 million

So stock price per share = Market value of equity/number of shares = 758.32/200 = $3.8 per share

So, company stock price today = $3.8 per share.