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Homework answers / question archive / Quantitative Problem 1: Assume today is December 31, 2013
Quantitative Problem 1: Assume today is December 31, 2013. Barrington Industries expects that its 2014 after-tax operating income [EBIT(1 – T)] will be $450 million and its 2014 depreciation expense will be $60 million. Barrington's 2014 gross capital expenditures are expected to be $110 million and the change in its net operating working capital for 2014 will be $25 million. The firm's free cash flow is expected to grow at a constant rate of 6% annually. Assume that its free cash flow occurs at the end of each year. The firm's weighted average cost of capital is 8.9%; the market value of the company's debt is $2 billion; and the company has 180 million shares of common stock outstanding. The firm has no preferred stock on its balance sheet and has no plans to use it for future capital budgeting projects. Using the corporate valuation model, what should be the company's stock price today (December 31, 2013)? Do not round intermediate calculations. Round your answer to the nearest cent.
$ per share
Quantitative Problem 2: Hadley Inc. forecasts the year-end free cash flows (in millions) shown below.
Year | 1 | 2 | 3 | 4 | 5 |
FCF | -$22.65 | $37.1 | $43.9 | $52.7 | $55.4 |
The weighted average cost of capital is 9%, and the FCFs are expected to continue growing at a 3% rate after Year 5. The firm has $24 million of market-value debt, but it has no preferred stock or any other outstanding claims. There are 18 million shares outstanding. What is the value of the stock price today (Year 0)? Round your answer to the nearest cent. Do not round intermediate calculations.
$ per share
Solution to the FIRST QUETSION
Step-1, Free Cash Flow (FCF)
Free Cash Flow (FCF) = Net Operating Profit After Tax(NOPAT) + Depreciation Expenses - Capital Expenditures – Changes in Net Working Capital
=EBIT(1 – Tax Rate) + Depreciation - Capital Expenditures – Changes in Net Working Capital
= $450 Million + $60 Million - $110 Million – $25 Million
= $375 Million
Step-2, Total Firm Value
Weighted Average Cost of Capital (WACC) = 8.90%
Growth Rate (g) = 6.00%
Therefore, the Total Firm Value = FCF / (WACC – g)
= $375 Million / (0.0890 – 0.06)
= $375 Million / 0.0290
= $12,931.03 Million
Step-3, Value of Common Equity
Value of Common Equity = Total Firm Value - Market Value of Debt
= $12,931.03 Million - $2,000 Million
= $10,931.03 Million
Step-4, Stock price today
The Stock price today = Value of Common Equity / Number of shares of common stock outstanding
= $10,931.03 Million / 180 Million common shares outstanding
= $60.73 per share
Hence, the company's stock price today will be $60.73.