Question

you are building a free cash flow to the firm model. you expect sales to grow from 1.4 billion for the year that just ended to 2.24 billion five years from now. assume that the company will not become any more or less efficient in the future. use the following information to calculate the value of the equity on a per share basis.

A) assume that the company currently has 420 million of net PP&E

B) The company currently has 140 million of networking capital

C) The company has operating margins of 12% and has an effective tax rate of 31%

D) The company has a weighted average cost of capital of 10%. This is based on a capital structure of 2/3 equity and 1/3 debt

E) The firm has 1 million shares outstanding

do not round intermediate calculations. Round your answer to the nearest cent.

Answer 1

Explanation:

Computation of Growth rate

Expected sales for the 1st year end is 1.4 Billion and expected sales in the 5th year is 2.24 Billion which means total sales at the end of 1st year is 1.4 billion which is expected to have sales in 5th year to 2.24 billion, so in between to grow there is 4 years)

Growth rate of sales is found through annuity factor formula FV = PV * (1+r)^n

2.24 =1.4 *(1+r) ^4

(1+r) ^5= 2.24/1.4

(1+r) =4 square root of 1.6   

(1+r) =1.1246

r=12.46% per year

Value of firm is computed as:

Year	sales (in million)	operating profit (12% of sales)	Tax (31% on operating profit)	Profit after tax	changes in working capital)	FCFF (profit after tax - change in WC)	Discounting at WACC 10%
1	1400	168	52.08	115.92	17.444	98.476	89.5236364
2	1574.44	188.933	58.5692	130.364	19.6175	110.746	91.5257104
3	1770.62	212.474	65.8669	146.607	22.0619	124.545	93.5725581
4	1991.23	238.948	74.0739	164.874	24.8108	140.063	95.6651808
5	2239.34	268.721	83.3035	185.417	27.9022	157.515	97.8046021
Total value of the firm							468.091688

Year	Working capital (in millions)	changes
0	140
1	157.444	17.444
2	177.062	19.6175
3	199.123	22.0619
4	223.934	24.8108
5	251.836	27.9022
Working capital changes (based on growth rate 12.46%)

Capital structure = (2/3) rd. equity and (1/3) rd. debt

Value of equity using (FCFF model) = Total value of firm * 2/ 3  

=> $468.091688* (2/3)

=>$312 million

Value of Equity per share = 312 million / 1 million shares

Value of Equity per share =$312 per share