Question

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?

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