Question

TLP corporation had operating cash flow of $3.20 per share last year, and has 1.5 million shares outstanding. Operating cash flows are expected to grow by 4% per year in the long run, i.e. forever. To attain this growth, TLP will need to make new capital expenditures in an amount equal to 40% of each year’s operating cash flow. TLP also has existing liabilities with a market value of $3 million.

(a) If TLP has no other assets, and a discount rate of 13% per year is appropriate, what is the fair market value of a share of TLP stock?

(b) Assume now that TLP has just made a breakthrough in biomedical engineering. The new project will require an immediate capital expenditure of $2.5 million, plus another $3.2 million outlay after one year. At the end of the second year the project will generate positive cash flow of $1.6 million. Subsequent cash flows from the project will grow by 4% per year in perpetuity. Given that TLP has made this breakthrough, and still assuming a 13% discount rate, what is the fair market value of a share of TLP stock?

Answer 1

THE TOTAL CASH FLOW FOR A SHARE IS = 3.2

THE AMOUNT OF CAPITAL EXPENDITURE = 3.2*40%

= 1.28

= NET CASH FLOW = 1.92

NOW VALUE OF EQUITY AS PER FREE CASH FLOW FOR EQUITY APPROACH

VALUE OF EQUITY = CASH FLOW AFTER 1 YEAR/R-G

WHERE R IS DISCOUNT RATE AND G IS THE CONSTANT GROWTH RATE

= 1.92*1.04/13%-4%

=22.18

LESS VALUE OF LIABILITY PER SHARE = 3/1.5=2

= 22.18-2

= 20.18

NOW SECOND PART

WE SHALL CALCULATE THE NET PRESENT VALUE OF THE NEW PROJECT

TOTAL PRESENT VALUE OF CASH OUTLAY = 2.5 + 3.2/1.13

= 5.33

NOW TOTAL PRESENT VALUE OF FUTURE CASH FLOWS = 1.6/(1.13)2 + 1.6(1.04)*PVIF(13%,3)/ 13% - 4%

= 1.253 + 12.813

= 14.06

CASH FLOWS AFTER THIRD YEAR HAS BEEN CALCULATED USING PERPETUITY WITH GROWTH

NOW NET PRESENT VALUE = 14.06- 5.33

= 8.73 MILLION

NOW VALUE ADDED PER SHARE = 8.73/1.5

= 5.82 PER SHARE

NEW VALUE = 20.18+ 5.82

= $ 26 PER SHARE