University of Texas, San Antonio

FINANCE 3013

1)The Discounted Free Cash Flow Model

P 10-1 (similar to) This year, FCF Inc. has earnings before interest and taxes of $9,350,000, depreciation expenses of $1,100,000, capital expenditures of $1,800,000, and has increased its net working capital by $500,000. If its tax rate is 30%, what is its free cash flow?

P 10-2 (similar to) Victoria Enterprises expects earnings before interest and taxes (EBIT) next year of $1.7 million. Its depreciation and capital expenditures will both be $287,000, and it expects its capital expenditures to always equal its depreciation. Its working capital will increase by $51,000 over the next year. Its tax rate is 37%. If its WACC is 9% and its FCFs are expected to increase at 4% per year in perpetuity, what is its enterprise value?

P 10-3 (similar to) The present value of JECK Co.'s expected free cash flow is $108 million. If JECK has $29 million in debt, $6 million in cash, and 3.4 million shares outstanding, what is its share price?

P 10-4 (similar to) Portage Bay Enterprises has $4 million in excess cash, no debt, and is expected to have free cash flow of $13 million next year. Its FCF is then expected to grow at a rate of 4% per year forever. If Portage Bay's equity cost of capital is 13% and it has 6 million shares outstanding, what should be the price of Portage Bay stock?

P 10-5 (similar to) River Enterprises has $505 million in debt and 21 million shares of equity outstanding. Its excess cash reserves are $17 million. They are expected to generate $199 million in free cash flows next year with a growth rate of 2% per year in perpetuity. River Enterprises' cost of equity capital is 11%. After analyzing the company, you believe that the growth rate should be 3% instead of 2%. How much higher (in dollars) would the price per share be if you are right?

P 10-6 (similar to) Heavy Metal Corporation is expected to generate the following free cash flows over the next five years:

Thereafter, the free cash flows are expected to grow at the industry average of 3.5% per year. Using the discounted free cash flow model and a weighted average cost of capital of 13.2%:

1. 1. 1. 
         Estimate the enterprise value of Heavy Metal. The enterprise value will be:

1. 1. 2. If Heavy Metal has no excess cash, debt of $299 million, and 35 million shares outstanding, estimate its share price.

P 10-7 (similar to) Covan, Inc. is expected to have the following free cash flow:

Year      1      2      3      4                             •••

FCF      12    14  15    16             Grow by 5% per year

1. Covan has 6 million shares outstanding, $2 million in excess cash, and it has no debt. If its cost of capital is 13%, what should be its stock price?
2. Covan reinvests all its FCF and has no plans to add debt or change its cash holdings (it does not invest its cash holdings). If you plan to sell Covan at the beginning of year 2, what is its expected price?
3. Assume you bought Covan stock at the beginning of year 1. What is your expected return from holding Covan stock until year 2?

P 10-8 (similar to) Sora Industries has 60 million outstanding shares, $125 million in debt, $57 million in cash, and the following projected free cash flow for the next four years:

Year        0           1          2          3             4

Earnings and FCF Forecast ($ million)

)          )          )          )

4     Gross Profit                                                                       154.4 170.3 180.5 189.5

5     Selling, General, & Admin.                                                 (93.6)

(103.2 (109.4 (114.9

1. Suppose Sora's revenue and free cash flow are expected to grow at a 3.2% rate beyond year four. If Sora's weighted average cost of capital is 14.0%, what is the value of Sora stock based on this information?
2. Sora's cost of goods sold was assumed to be 67% of sales. If its cost of goods sold is actually 70% of sales, how would the estimate of the stock's value change?

3. Return to the assumptions of part (a) and suppose Sora can maintain its cost of goods sold at 67% of sales. However, the firm reduces its selling, general, and administrative expenses from 20% of sales to 16% of sales. What stock price would you estimate now? (Assume no other expenses, except taxes, are affected.)
4. Sora's net working capital needs were estimated to be 18% of sales (their current level in year zero). If Sora can reduce this requirement to 12% of sales starting in year 1, but all other assumptions are as in (a), what stock price do you estimate for Sora? (Hint: This change will have the largest impact on Sora's free cash flow in year 1.)

P 10-9 (similar to) Consider the following data for Nike Inc.: In 2009 it had $19,000 million in sales with a 10% growth rate in 2010, but then slows by 1% to the long-run growth rate of 5% by 2015. Nike expects EBIT to be 10% of sales, increases in net working capital requirements to be 10% of any increases in sales, and capital expenditures to equal depreciation expenses. Nike also has $2,300 million in cash, $32 million in debt, 486 million shares outstanding, a tax rate of 24%, and a weighted average cost of capital of 10%.

1. Suppose you believe Nike's initial revenue growth rate will be between 7% and 11% (with growth slowing linearly to 5% by year 2015). What range of prices for Nike stock is consistent with these forecasts?

2. Suppose you believe Nike's initial revenue EBIT margin will be between 9% and 11% of sales. What range of prices for Nike stock is consistent with these forecasts?
3. Suppose you believe Nike's weighted average cost of capital is between 9.5% and 12%. What range of prices for Nike stock is consistent with these forecasts?

4. What range of stock prices is consistent if you vary the estimates as in parts (a), (b), and (c) simultaneously?

P 10-9 (similar to) Consider the following data for Nike Inc.: In 2009 it had $19,150 million in sales with a 10% growth rate in 2010, but then slows by 1% to the long-run growth rate of 5% by 2015. Nike expects EBIT to be 10% of sales, increases in net working capital requirements to be 10% of any increases in sales, and capital expenditures to equal depreciation expenses. Nike also has $2,300 million in cash, $32 million in debt, 486 million shares outstanding, a tax rate of 24%, and a weighted average cost of capital of 10%.

1. Suppose you believe Nike's initial revenue growth rate will be between 7% and 11% (with growth slowing linearly to 5% by year 2015). What range of prices for Nike stock is consistent with these forecasts?

2. Suppose you believe Nike's initial revenue EBIT margin will be between 9% and 11% of sales. What range of prices for Nike stock is consistent with these forecasts?
3. Suppose you believe Nike's weighted average cost of capital is between 9.5% and 12%. What range of prices for Nike stock is consistent with these forecasts?

4. What range of stock prices is consistent if you vary the estimates as in parts (a), (b), and (c) simultaneously?

P 10-10 (similar to) You are evaluating the stock price of Kroger, a grocery store chain. It has forward earnings per share of $3.15. You notice that its competitor Safeway has a P/E ratio of

P 10-11 (similar to) You notice that Coca-Cola has a stock price of $41.54 and EPS of $1.84. Its competitor PepsiCo has EPS of $4.16. But, Jones Soda, a small batch Seattle-based soda producer has a P/E ratio of 36. Based on this information, what is one estimate of the value of a share of PepsiCo stock?

P 10-12 (similar to) CSH has EBITDA of $3 million. You feel that an appropriate EV/EBITDA ratio for CSH is 10. CSH has $11 million in debt, $5 million in cash, and 775,000 shares outstanding. What is your estimate of CSH's stock price?

P 10-13 (similar to) Next year, BHH Co. is expected to pay a dividend of $2.97 per share from earnings of $4.76 per share. The equity cost of capital for BHH is 11.7%. What should BHH's forward P/E ratio be if its dividend growth rate is expected to be 4% for the foreseeable future?

P 10-14 (similar to) GHL, Inc., has a dividend payout ratio of 55%. Its cost of equity is 11.2% and its dividend growth rate is 5.1%. If its forward EPS is $5.96, what is your estimate of its stock price?

P 10-15 (similar to) SLYMN Enterprises has a P/E ratio of 12.5 and a dividend payout ratio of 35%. If its equity cost of capital is 13.4%, what growth rate is its P/E ratio consistent with?

P 10-16 (similar to) After researching the competitors of EJH Enterprises, you determine that most comparable firms have the following valuation ratios:

EJH Enterprises has EPS of $1.90, EBITDA of $295 million, $30 million in cash, $43 million in debt, and 100 million shares outstanding. What range of prices is consistent with both sets of multiples?

P 10-17 (similar to) Suppose that in July 2013, Nike Inc. had EPS of $2.45 and a book value of equity of $11.74 per share.

Minimum            −62%            −63%            −48%                     −34%

1. 
   Using the average P/E multiple from the table above, estimate Nike's share price. Nike’s share price for this case will be:
2. What range of share prices do you estimate based on the highest and lowest P/E multiples in the table above?
3. Using the average price to book value multiple in the table above, estimate Nike's share price. Nike’s share price for this case will be:
4. What range of share prices do you estimate based on the highest and lowest price-to-book value multiples in the table above?

P 10-18 (similar to) Suppose that in July 2013, Nike Inc. had sales of $25,323 million, EBITDA of

$3,259 million, excess cash of $3,341 million, $1,386 million of debt, and 887.2 million shares outstanding.

P                Price

E                Book

Enterpris e

Enterprise Value EBITDA

1. Using the average enterprise value to sales multiple in the table above, estimate Nike's share price.

2. What range of share prices do you estimate based on the highest and lowest enterprise value to sales multiples in the table above?

3. What range of share prices do you estimate based on the highest and lowest enterprise value to EBITDA multiples in the table above?

P 10-19 (similar to) Suppose Rocky Brands has earnings per share of $2.23 and EBITDA of $29.4 million. The firm also has 5.7 million shares outstanding and debt of $120 million (net of cash). You believe Deckers Outdoor Corporation is comparable to Rocky Brands in terms of its underlying business, but Deckers has no debt. If Deckers has a P/E of 12.9 and an enterprise value to EBITDA multiple of 7.8, estimate the value of Rocky Brands stock using both multiples. Which estimate is likely to be more accurate?

P 10-20 (similar to) Consider the following data for the airline industry for December 2015 (EV = enterprise value, Book = equity book value). Discuss the potential challenges of using multiples to value an airline.

All the multiples show a great deal of variation, suggesting the following:

Which of these ratios is probably the most useful?

P 10-21 (similar to) Consider the following data for the airline industry for December 2015 (EV = enterprise value, Book = equity book value). Suppose Hawaiian Airlines (HA) has 53.1 million shares outstanding. Estimate Hawaiian's share value using each of the five valuation multiples shown here, based on the median valuation multiple of the other seven airlines shown.

Calculate Hawaiian's share values using each of the five valuation multiples below:

P 10-22 (similar to) Summit Systems has an equity cost of capital of 11.0%, will pay a dividend of

$1.50 in one year, and its dividends had been expected to grow by 7.0% per year. You read in the paper that Summit Systems has revised its growth prospects and now expects its dividends to grow at a rate of 3.0% per year forever.

1. 
   What is the drop in value of a share of Summit Systems stock based on this information? The drop in value of a share of Summit Systems stock is:

2. If you tried to sell your Summit Systems stock after reading this news, what price would you be likely to get? Why?

P 10-23 (similar to) Assume that Cola Co. has a share price of $42.48. The firm will pay a dividend of $1.24 in one year, and you expect Cola Co. to raise this dividend by approximately 6.2% per year in perpetuity.

1. If Cola Co.'s equity cost of capital is 8.5%, what share price would you expect based on your estimate of the dividend growth rate?

2. Given Cola Co.'s share price, what would you conclude about your assessment of Cola Co.'s future dividend growth?

P 10-24 (similar to) Roybus, Inc., a manufacturer of flash memory, just reported that its main production facility in Taiwan was destroyed in a fire. Although the plant was fully insured, the loss of production will decrease Roybus's free cash flow by $178 million at the end of this year and by $55 million at the end of next year.

1. If Roybus has 36 million shares outstanding and a weighted average cost of capital of 13.5%, what change in Roybus's stock price would you expect upon this announcement? (Assume that the value of Roybus's debt is not affected by the event.)
2. Would you expect to be able to sell Roybus stock on hearing this announcement and make a profit? Explain.

P 10-25 (similar to) Apnex, Inc., is a biotechnology firm that is about to announce the results of its clinical trials of a potential new cancer drug. If the trials are successful, Apnex stock will be worth $60 per share. If the trials are unsuccessful, Apnex stock will be worth $18 per share.

Suppose that the morning before the announcement is scheduled, Apnex shares are trading for

$58 per share.

1. Based on the current share price, what sort of expectations do investors seem to have about the success of the trials?

2. Suppose hedge fund manager Paul Kliner has hired several prominent research scientists to examine the public data on the drug and make their own assessment of the drug's promise. Would Kliner's fund be likely to profit by trading the stock in the hours prior to the announcement?

3. Which factors would limit the ability of Kliner's fund to profit on its information?