Question

ThefollowingforecastsforGassonTronicsweretakenfromanalyst’sreportsinthefourth quarterof2018 ($ millions).

IncomeStatement:	2019	2020	2021	2022	2023
Revenues	1900	2075	2311	2598	2919
OperatingExpenses(bef int. &dep.)	1371	1546	1747	1975	2240
Depreciation	100	107	111	114	107
BalanceSheet:
Change inNet WorkingCapital	81	91	103	116	129
Additions toGross FixedAssets (CAPEX)	174	190	205	220	225
OtherInformation
Expectedeffective taxrate	30%
Debt / Total Capital	40%
Marginal Debt Rate	4%
Beta	0.70
Risk FreeRate	2.75%
ExpectedMarket Return	9.75%
Cash & Non-Operating Assets (mil)	150
Outstandingshares (mil)	70

Usetheaboveinformationtoanswerthefollowingquestions:

A. UsingtheCapitalAssetPricingModel,estimatethecostofequity.

                    

B. Estimatetheweightedaveragecostofcapitalassumingthecompanymaintainsitscurrent capitalstructure.

C. Estimate the share price using Free Cash Flows toall providersofc apita land assuming the company’s cash flows continue to grow a t3% after the forecas tperiod.

Answer 1

a). Cost of equity ke = risk-free rate + beta*market risk premium = 2.75% + 0.70*(9.75%-2.75%) = 7.65%

b). Cost of debt = 4%

After-tax cost of debt kd = 4%*(1-tax rate) = 4%*(1-30%) = 2.80%

Debt/Total Capital (D/TC) = 40%

Therefore, Equity/Total Capital (E/TC) = 60%

WACC = ke*(E/TC) + kd*(D/TC) = (7.65%*0.6) + (2.80%*0.4) = 5.71%

c).

	(n)	1	2	3	4	5	5
Formula	Year (t)	2019	2020	2021	2022	2023	Perpetuity
	Growth rate						3%
	Revenues ('R)	1,900.00	2,075.00	2,311.00	2,598.00	2,919.00	-
	Op. expenses (O)	1371	1546	1747	1975	2240
	Dep. (D)	100	107	111	114	107
(R-O-D)	EBIT	429.00	422.00	453.00	509.00	572.00	-
30%*EBIT	Tax @30%	128.70	126.60	135.90	152.70	171.60	-
(EBIT-Tax)	Net income (NI)	557.70	548.60	588.90	661.70	743.60	-
	Add: dep.	100	107	111	114	107
(NI + D)	Op.Cash Flow (OCF)	657.70	655.60	699.90	775.70	850.60	-
	Less: Change in NWC	81	91	103	116	129
	Less: Capex	174	190	205	220	225
(OCF-nwc-capex)	FCFF	912.70	936.60	1,007.90	1,111.70	1,204.60	1,240.74
(1st perpetuity cash flow/(k-g)	Terminal CF						45783.69
	Total CF	912.70	936.60	1,007.90	1,111.70	1,204.60	45,783.69
1/(1+WACC)^n	Discount factor	0.9460	0.8949	0.8465	0.8008	0.7576	0.7576
(Total CF*discount factor)	PV of CFs	863.40	838.15	853.24	890.27	912.56	34,684.10
Sum of all PVs	EV	39,041.72

Note: Gross debt is not given so equity value cannot be calculated. I have left it with the Enterprise Value calculation.

You can calculate total equity value by EV - gross debt + cash and other non-operating assets.