At the end of the year 2010 the CL Corporation had operating free cash flow (OFCF) of $300,000 and shares outstanding of 100,000. Total debt is currently $10,000,000. The company projects the following annual growth rates in OFCF
Year |
Growth Rate |
2011 |
25% |
2012 |
20% |
2013 |
15% |
2014 |
10% |
2015 |
12% |
2016 |
14% |
2017 |
16% |
2018 |
18% |
From year 2019 onward growth in OFCF is expected to remain constant at 5% per year. The stock has a beta of 1.1 and the current market price is $80. Currently the yield on 10-year Treasury notes is 5% and the equity risk premium is 4%. The firm can raise debt at a pre-tax cost of 9%. The tax rate is 25%. The proportion of equity is 55% and the proportion of debt is 45%.
A)Calculate the required rate of return on equity.
B)Calculate the weighted average cost of capital (WACC).
C)Calculate the present value now (Year 2010) of OFCF during the period of declining growth (that is for years 2011 to 2014).
D) Calculate the present value now (Year 2010) of OFCF during the period of declining growth (that is for years 2015 to 2018).
E) Calculate the present value now (Year 2010) of OFCF during the period of constant growth (that is for years 2019 onwards).
F) Calculate the total intrinsic value of the firm.
G) Calculate the intrinsic value of the stock now (Year 2010).
A) REQUIRED RATE OF RETURN ON EQUITY
Calulated using CAPM model
Rate of return on equity= Risk free rate+beta*risk premium
=(0.05+1.1*0.04)*100
=9.4%
B) WEIGHTED AVERAGE COST OF CAPITAL
particulars rate of return (a) (b) weight product( a*b)
Equity 9.4% 0.55 5.17
Debt(after tax) 6.75% 0.45 3.04
(0.09-25%of 0.09)*100
TOTAL(WACC) 8.21
ANSWER FOR PART (C)
year cash flow PVF@ 8.21% DCF
2011 300000+25%=375000 0.924 346500
2012 375000+20%=450000 0.854 384300
2013 450000+15%=517500 0.789 408308
2014 517500+10%=569250 0.729 414983
Present value of cash flows during declining period 1554091
D)present value of declining growth
year cash flow [email protected]% DCF
2015 569250+12%=637560 0.674 429715
2016 637560+14%=726818 0.623 452808
2017 726818+16%=843109 0.576 485631
2018 843109+18%=994869 0.532 529270
TOTAL 1897424
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