In: Finance
Cleanlab Inc. sells chemicals and systems for cleaning, sanitizing, and maintenance. It recently reported earnings per share of $2.55 and expects earnings growth of 8% a year for the next two years and 4% a year after that. The capital expenditure per share was $2.15, depreciation was $1.05 per share, and working capital expenditure was $0.25 per share and all three are expected to grow at the same rate as earnings. The firm has a target debt ratio of 40%, the stock’s beta is 1.20, the risk-free rate is 3.0% and the equity risk premium is 6%.
Step 1 - Computation of cost of equity using CAPM method
Cost of equity = Risk Free Rate + (Beta * Equity Risk Premium) = 3%+(1.2*6%) = 10.2%
Step 2 - Computation of Free-Cash Flows:
Working
FCFF = The capital expenditure (adjusted for depreciation) and working capital expenditure gets offset partially by debt which is at 0.4 (target debt ratio given in question).
Step 3 - Computation of terminal value
Terminal Value = (FCFF of year 3 *(1+growth %)) / (cost of equity - growth %) = (2.111*(1+4%))/(10.2%-4%) = $35.41
Step 4 - Computation of Intrinsic Value of Share
Intrinsic Value = Present Value of FCFF + Present Value of Terminal Value
= (1.879*(1/(1+10.2%)^1))+(2.030*(1/(1+10.2%)^2))+(2.111*(1/(1+10.2%)^3))+(35.41*(1/(1+10.2%)^3)) = 1.705+1.671+1.577+26.456 = 31.41
Thus, intrinsic value per share is $31.41 (option a)