Question

The corporate valuation model, the price-to-earnings (P/E) multiple approach, and the economic value added (EVA) approach are some examples of valuation techniques. The corporate valuation model is similar to the dividend-based valuation that you’ve done in previous problems, but it focuses on a firm’s free cash flows (FCFs) instead of its dividends. Some firms don’t pay dividends, or their dividends are difficult to forecast. For that reason, some analysts use the corporate valuation model.

Charles Underwood Agency Inc. has an expected net operating profit after taxes, EBIT(1 – T), of $14,200 million in the coming year. In addition, the firm is expected to have net capital expenditures of $2,130 million, and net operating working capital (NOWC) is expected to increase by $35 million. How much free cash flow (FCF) is Charles Underwood Agency Inc. expected to generate over the next year?

$12,035 million

$16,295 million

$288,976 million

$12,105 million

Charles Underwood Agency Inc.’s FCFs are expected to grow at a constant rate of 3.54% per year in the future. The market value of Charles Underwood Agency Inc.’s outstanding debt is $76,494 million, and its preferred stocks’ value is $42,496 million. Charles Underwood Agency Inc. has 525 million shares of common stock outstanding, and its weighted average cost of capital (WACC) equals 10.62%.

Term	Value (Millions)
Total firm value
Intrinsic value of common equity
Intrinsic value per share

Using the preceding information and the FCF you calculated in the previous question, calculate the appropriate values in this table. Assume the firm has no nonoperating assets.

Answer 1

Answer a.

Expected Free Cash Flow = EBIT * (1 - tax) - Capital Expenditures - Change in Net Operating Working Capital
Expected Free Cash Flow = $14,200 million - $2,130 million - $35 million
Expected Free Cash Flow = $12,035 million

Answer b.

Value of Firm = Expected Free Cash Flow / (WACC - Growth Rate)
Value of Firm = $12,035 million / (0.1062 - 0.0354)
Value of Firm = $12,035 million / 0.0708
Value of Firm = $169,986 million

Value of Equity = Value of Firm - Value of Debt - Value of Preferred Stock
Value of Equity = $169,986 million - $76,494 million - $42,496 million
Value of Equity = $50,996 million

Price per share = Value of Equity / Number of shares outstanding
Price per share = $50,996 million / 525 million
Price per share = $97.14