Question

Assume you are trying to find an estimate of PrintTronics Inc.'s share price using the flow...

Assume you are trying to find an estimate of PrintTronics Inc.'s share price using the flow to equity method.  PrintTronics’ current EBIT is $2 million.  The firm's tax rate is 40% and the firm’s current beta is 1.265.  You estimate that the market risk premium is 6% and the current risk-free rate is 4%. The firm has $3,000,000 in perpetual debt outstanding with a cost of 8%, the firm has 250,000 shares outstanding, and you expect the firm’s levered cash flow to grow at 3% forever.

A. What is the firm’s levered cost of equity?

B. What is the value of the firm's equity?

C. What is your estimate of the firm's share price?

Homework Answers

Answer #1

(a) Beta = 1.265, Risk-Free Rate = Rf = 4 % and Market Risk-Premium = MRP = 6 %

Levered Cost of Equity = Rf + Beta x MRP = 4 + 1.265 x 6 = 11.59 %

(b) Perpetual Debt = $ 3000000 and Interest Rate = 8 %

EBIT = $ 2 million

Less: Interest Expense = 0.08 x 3000000 = $ 240000 or $ 0.24 million

Profit Before Tax (PBT) = $ 1.76 million

Less: Tax Expense @ 40 % = 0.4 x 1.76 = $ 0.704 million

Net Income = $ 1.056 million

Add: Depreciation = $ 0 (not mentioned hence assumed zero)

Less: Investment in Fixed Capital = $ 0 (not mentioned hence assumed zero)

Less: Investment in Net Working Capital (NWC) = $ 0 (not mentioned hence assumed zero)

Free Cash Flow to Equity (FCFE) = $ 1.056 million

Growth Rate of FCFE = 3 %

Therefore, Equity Value = [1.056 x 1.03] / [0.1159 - 0.03] = $ 12.6622 million

(c) Number of Shares Outstanding = 250000

Price per Share = 12662165.3 / 250000 = $ 50.64866 ~ $ 50.65

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