Question

CONSIDER:

In Period 1 (at the end of the period):

Net Income = 300

Interest Expense = 100

Depreciation = 40

Cap Ex = 43

Net Increases to Working Capital = 10

Cash Flow to Invested Capital = NI + D&A - Cap Inv + Interest Exp – Net Add to Work Cap

CFIC = 300 + 40 – 43 + 100 – 10

CFIC = 387

NOW CONSIDER:

CF1 = 387

CF2 = 1.333 x CF1 = 515.871

CF3 = 1.25 x CF2 = 644.83875

Debt = 2,200

D/E (books) = 0.8

The firm has 150 shares of stock issued and outstanding.

Spot price of stock was $45 per share at last business day close.

Long-term sustainable growth is then 2.3% going forward from there.

Equity Risk Premium = 6%

Risk Free Rate = 2%

Beta = 1.25

Cost of Debt = Interest Expense/Debt = 100/2200 = 4.545%

Cost of Equity = RFR + Beta x ERP = .02 + (1.25 x .06) = 9.5%

Corporate Tax = 30%      

WACC (discount rate) = 6.69%

Using end-of-year discounting:

What is the intrinsic value of Invested Capital?

a. 877

b. 1000

c. 13,933

d. 4,250

Answer 1

First of all we will calculte the present value of explicit forecast period

Year	CFIC	PV @ 6.69%
1	387.00	362.73
2	515.87	453.20
3	644.84	530.98
	PV	1,346.92

Present Value of Explicit forecast period = 1346.92

Now we will calculate terminal value at Year 3

Terminal Value at Year 3 = CF3(1+g) / WACC-g

Terminal Value at Year 3 = 644.84*1.023 / (0.0669-0.023)  

Terminal Value at Year 3 = 15027

Terminal Value at Year 0 = 15027 / 1.0669^3 = 12373.45

Intrensic Value of Invested Capital = 12373.45 + 1346.92 = 13,720 (which is approximately equal to 13,933 due to rounding difference in calculations)

So the correct answer is Option C