Question

A company just reported the following results for its most recent fiscal year (year 0): Total revenues: $500 million, Operating profit margin: 40%, Tax rate: 25%, Reinvestment rate: 60%. It has $300 million debt and $2 million cash. Number of shares outstanding is 20 million. You forecast that the company will earn the same FCFF next year (FCFF1), which will then decline at a stable 4% rate (i.e., a negative growth rate) in perpetuity thereafter. You estimate that the company's cost of capital is 14%. How much would you be willing to pay for each share?

		a. $1.8
		b. $2.7
		c. $3.9
		d. $5.1
		e. $6.5

Answer 1

Operating profit = Total revenues * operating profit margin
= $500 million * 0.40
= $200 million

Net operating profit after tax (NOPAT) = operating profit * (1 - t)
= $200 million * (1 - 0.25)
= $150 million

FCFF1 = NOPAT * (1-Reinvestment rate)
= $150 million * (1 - 0.60)
= $60 million

Enterprice value = FCFF1 / (Cost of capital - growth rate)
= $60 million / (0.14 - (-0.04))
= $60 million / 0.18
= $333.33

Firm value = Market value of debt + Market value of equity - cash
$333.33 million = $300 million + Market value of equity - $2 million
Market value of equity = $333.33 million + $2 million - $300 million
Market value of equity = $35.33 million

Market value of equity = Number of shares outstanding * current share price
$35.33 million = 20 million * current share price
current share price = $35.33 million / 20 million
current share price = $1.8

Price per share = $1.8