The corporate valuation model, the price-to-earnings (P/E) multiple approach, an
ID: 2641738 • Letter: T
Question
The corporate valuation model, the price-to-earnings (P/E) multiple approach, and the economic value-added (EVA) approach are some examples of valuation techniques. The corporate valuation model is similar to the dividend-based valuation, but it focuses on a firm's free cash flows (FCFs) instead of its dividends and works best in cases when firms don't pay dividends, or their dividends are difficult to forecast. Gadget Twin Inc. has an expected net operating profit after taxes, EBIT(1 - T), of $900 million in the coming year. In addition, the firm is expected to have net capital expenditures of $135 million, and net working capital (NWC) is expected to increase by $30 million. How much free cash flow (FCF) is Gadget Twin Inc. expected to generate over the next year? Gadget Twin Inc.'s FCF5 are expected to grow at a constant rate of 2.82% per year in the future. The market value of Gadget Twin Inc.'s outstanding debt is $5,864 million, and preferred stocks' value is $3,258 million. Gadget Twin Inc. has 450 million shares of common stock outstanding, and its weighted average cost of capital (WACC) equals 8.46%. Using the preceding information and the FCF you calculated in the previous question, calculate the appropriate values in this table.Explanation / Answer
PAT = $900 mn
Net capital Expenditure =$135 mn
Increase in net working capital = $30 mn
Free cash flow = Net income + Non cash charges - Capital Expenditures - Increse in working capital
FCF = $900 mn - $135mn - $30 mn
FCF = $ 735 mn
Growth rate in FCF = 2.82%
MV of debt = $5,864 mn
MV of preferred stock = $3,258 mn
Common stock = 450 mn
WACC = 8.46%
As there is a constant growth, the value of the firm according to the constant growth model =
Value of the firm = FCF/Ke-g
Where , ke = WACC
Value of the firm = $735 mn/0.0846 - 0.0282
Value of the firm = $13,031.91 mn
Value of equity = Value of firm - Value of Debt - Value of Preferred stock
Value of equity = $13,031.91 mn - $5,864 - $3,258
Value of Equity = $ 3,909.91 mn
Intrinsic value per share = Value of equity/Number of equity shares
Intrinsic value = $3,909.91mn/450mn
Intrinsic Value = $ 8.688 per share
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