Question

Assume that today is December 31, 2018, and that the following information applies to Abner Airlines:

After-tax operating income [EBIT(1 - T)] for 2019 is expected to be $550 million.

The depreciation expense for 2019 is expected to be $50 million.

The capital expenditures for 2019 are expected to be $475 million.

No change is expected in net operating working capital.

The free cash flow is expected to grow at a constant rate of 7% per year.

The required return on equity is 16%. The WACC is 11%.

The firm has $202 million of non-operating assets.

The market value of the company's debt is $3.183 billion.

200 million shares of stock are outstanding.

Using the corporate valuation model approach, what should be the company's stock price today? Do not round intermediate calculations. Round your answer to the nearest cent.

Answer 1

After tax operating income = EBIT(1-T) = $550 million

Depreciation = $50 million, Capital expenditure = $475, Change in net operating working capital = 0

Free cash flow to firm for 2019 = FCFF = EBIT(1-T) + depreciation - capital expenditure - change in net operating working capital = 550 + 50 - 475 - 0 = $125 million

WACC = 11%, Growth rate of free cash flow = g = 7%

Free cash flow valuation takes into consideration assets that generate operating cash flows, Hence will now use FCFF and constant growth rate model to find the value of operating assets of firm

Value of operating assets at end of 2018 = FCFF/ (WACC - g) = 125 / (11% - 7%) = 125 / 4% = $3125 million

We know that value of firm at end of 2018 = Value of operating assets + Value of non operating assets = 3125 + 202 = $3327 million

Value of debt = $3.183 billion = 3.183 x 1000 million = $3183 million

Value of equity = Value of firm - Market Value of debt = 3327 - 3183 = $144 million

No of shares outstanding = 200 million

Stock price of company = Value of equity / No of shares outstanding = $144 million / 200 million = = $0.72 (rounded to nearest cent)

Therefore stock price of company = $0.72