2. You have been asked to value Oneida Steel, a midsize steel company. The ?rm r

Question

2. You have been asked to value Oneida Steel, a midsize steel company. The ?rm reported $80 million in net income, $50 million in capital expenditures, and $20 million in depreciation in the just-completed ?nancial year. The ?rm reported that its noncash working capital increased by $20 million during the year and that total debt outstanding increased by $10 million during the year. The book value of equity at Oneida Steel at the beginning of the last ?nancial year was $400 million. The cost of equity is 12%.

a. Estimate the equity reinvestment rate, return on equity, and expected growth rate over the first give years for Oneida Steel. (You can assume that the ?rm will continue to maintain the same debt ratio that it used last year to ?nance its reinvestment needs.)

b. If this growth rate is expected to last ?ve years and then drop to a 4% stable growth rate after that and the return on equity after year 5 is expected to be 12%, estimate the value of equity today, using the projected free cash ?ows to equity. For the stable growth stage, the cost of equity is 10%.

c. Fill out the following table (the cells with question marks).

Year

1

2

3

4

5

6

Net Income

Equity reinvestment

FCFE

Terminal Value

PV of each year cash flow

Year

1

2

3

4

5

6

Net Income

Equity reinvestment

FCFE

Terminal Value

PV of each year cash flow

Explanation / Answer

Net income 80 Capex 50 Depreciation 20 Non Cash working capital increase 20 Debt outstanding increase 10 Opening equity 400 Cost of equity 12% a) Equity Reinvestment Rate, return on equity, expected growth rate over next 5 years Equity Reinvestment rate = Equity reinvested / Net income Equity reinvested = (Capital exp. - Depreciation + Working capital changes - (Debt raised - Debt repaid)) = (50-20 + 20-10) = 40 Equity Reinvestment rate = 40 / 80 Equity Reinvestment rate = 50.00% Return on equity = Net income / Equity = 80 / 400 Return on equity = 20.00% Expected growth = ( Equity reinvestment rate) X (Return on equity) = ( 50% ) X (20%) = 0.1

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