Question

In this assignment, you will apply the concepts of company valuation that you have just learned to determine whether company XYZ is overvalued.

We are currently at the end of year "t". You performed a thorough financial analysis of XYZ and forecast the following Free Cash Flows (FCF):

• Year t+1: 352 million USD
• Year t+2: 385 million USD
• Year t+3: 407 million USD

From year t+3 onward, you expect the FCFs to grow at a constant yearly rate of 4%.

Through your analysis, you also determined that the appropriate Weighted Average Cost of Capital (WACC) for XYZ was 11%.

Finally, you know that XYZ has 1000 million USD in debt and 100 million shares outstanding.

Answer 1

FCF in year t+4 = 407*1.04 =$423.28 million

Horizon value at the end of year 3 = FCF in year t+4 / (WACC - constant growth rate)

=423.28/(0.11-0.04)

  =$6046.857 million

So, value of firm = present value of FCFs

=352/1.11+385/1.11^2+407/1.11^3+ 6046.857/1.11^3

= $5348.60 million

Value of Equity = Value of firm - Value of Debt

=$5348.60 million - $1000  million

= $4348.60 million

Intrinsic value of one share = Value of Equity/ No of shares

= $4348.60 million/ 100 million shares

= $43.486 per share or $43.49 per share

So, if the market value of the share is above $43.49 per share , equity of Company XYZ is overvalued

and if the market value of the share is below $43.49 per share , equity of Company XYZ is undervalued.

If the market value of the share is exactly $43.49 per share , equity of Company XYZ is correctly valued