Question

Company ABC estimated revenue is 10 million in 2019 and 2% growth per year. Profit margin is stable annually and equals to 20%. Non-cash P&L items estimated at 12% of total sales. Company will purchase equipment at 2021 for 3 million. Interest expense is 800.000 annually and tax rate is 20%. Calculate FCFF for first 3 years. Explain the method you would use to calculate PV of future cash flows after year 3.

Using results, calculate value of the company if cost of capital is 5% and PV of future cash flows after year 3 is 14 million. Calculate the share price if there are 1 million outstanding shares. Would you invest in the company if market share price is 17$? Why?

Answer 1

FCFF = Net Income + Interest * (1-tax rate) + Non cash charges - working capital investment - capital expenditures

FCFF in 2019 (in millions) = 2 + 1.2 + 0.64 = 3.84

FCFF in 2020 = 2.04 + 1.224 + 0.64 = 3.90

FCFF in 2021 = 2.08 + 1.25 + 0.64 - 3 = 0.97

After year 3 we would estimate a stable growth rate of FCFF and calculate terminal value in year 3

terminal value in year 3 = FCFF in year 4 / WACC - g

Given that present value of cash flow after year 3 is 14 million. Lets calculate present value of FCFF in the 3 years using financial calculator CF function.

The present value of FCFF = 8.03 million

Value of firm = 14 + 8.03 = 22.03$ milliom

Value of firm per share = 22.03 / 1 million shares

value per share = 22.03$

If the current market price is 17$, we would invest in the company as the value is greater than price. Therefore there is a positive convergence yield that price of 17$ will converge to its value of 22.03$.