Question

We present 2 examples of the corporate valuation model. In the first problem, we assume that the firm is a mature company so its free cash flows grow at a constant rate. In the second problem, we assume that the firm has a period of nonconstant growth.

a.

Assume today is December 31, 2019. Barrington Industries expects that its 2020 after-tax operating income [EBIT(1 – T)] will be $410 million and its 2020 depreciation expense will be $60 million. Barrington's 2020 gross capital expenditures are expected to be $120 million and the change in its net operating working capital for 2020 will be $25 million. The firm's free cash flow is expected to grow at a constant rate of 5% annually. Assume that its free cash flow occurs at the end of each year. The firm's weighted average cost of capital is 8.1%; the market value of the company's debt is $2.3 billion; and the company has 180 million shares of common stock outstanding. The firm has no preferred stock on its balance sheet and has no plans to use it for future capital budgeting projects. Also, the firm has zero non-operating assets. Using the corporate valuation model, what should be the company's stock price today (December 31, 2019)? Do not round intermediate calculations. Round your answer to the nearest cent. $ per share

b.

Hadley Inc. forecasts the year-end free cash flows (in millions) shown below.

Year	1	2	3	4	5
FCF	-$22.34	$38.4	$43.2	$52.5	$55.3

The weighted average cost of capital is 12%, and the FCFs are expected to continue growing at a 4% rate after Year 5. The firm has $25 million of market-value debt, but it has no preferred stock or any other outstanding claims. There are 18 million shares outstanding. Also, the firm has zero non-operating assets. What is the value of the stock price today (Year 0)? Round your answer to the nearest cent. Do not round intermediate calculations.

$   per share

According to the valuation models developed in this chapter, the value that an investor assigns to a share of stock is dependent on the length of time the investor plans to hold the stock.

The statement above is (true/false).

Answer 1

EBIT(1-T) = $410 million

Add: Depreciation 60 million

Less: Gross Capital Expenditure = $120 million

Increase in Net Operating Working capital = $25 million

Free cash flow = $325 million

Firm Value = Free cash flow next year/(WACC – growth rate)

= 325/(8.1%-5%)

= $10,483.87 million

Less: Value of debt = $2,300 million

Value of Equity = $8183.87 million

Number of shares = 180 million

Intrinsic value per share = $45.47

2.Enterprise value = present value of all future free cash flows

= -22.34/(1.12)+38.4/(1.12)^2 + 43.2/(1.12)^3 + 52.5/(1.12)^4 + 55.3/(1.12)^5 + 55.3(1.04)/(1.12)^5(12%-4%)

= 514.08 million

Value per share = (514.08 – 25)/18

= $27.17 per share