SunTrust Telecom, Inc.(STT) provides centralized telephone systems in remote are

Question

SunTrust Telecom, Inc.(STT) provides centralized telephone systems in remote areas of underdeveloped countries. As a result of a recent world-wide economic downturn, the price of STT’s stock price has declined dramatically to around $30. Given the current economic outlook, however, and STT’s long-range earning forecast, Jackson Hamilton, CFO of STT believes that STT is currently trading below its intrinsic value. Since STT is supposed to issue new equity to finance a new project in near future, he feels that it needs to arrange an IR to publicize STT’s intrinsic equity value. In order to determine if STT is indeed underpriced, Jackson has assembled the information presented below to estimate the current value of STT’s stock using DCF model. He believes that STT’s FCFE will grow at 20 percent for three years after 2014, then stabilizes at 3 percent from 2018 onward. Jackson assumes that STT’s capital expenditures, depreciation, and working capital will change in direct proportion to FCFE. A required rate of return on equity is assumed to be 15 percent.

Estimate FCFEs from 2014 through 2018 and then calculate STT's per share intrinsic value as of the end of 2014 (Ignore the midyear adjustment)

MUse the formula introduced the lecture notes. FCFEE=NI -NetCAPEX - NetOA +NetFNCE

SunTrust Telecom Inc.,I/S 2014 2013 (millions) Net Sales 530 500 Cost (Excluding depreciation) 381.6 360 Depreciation 39.8 37.5        Total operating costs 421.4 397.5 Earinings before interest and tax 108.6 102.5        Less interest (16.0) (13.9) Earnings before taxes 92.6 88.6        Taxes (40%) (37.0) (35.4) Net income before preferred dividends 55.6 53.2        Preferred dividends (7.4) (6.0) Net income available for common dividends 48.2 47.2 common dividends 29.7 40.8 Additions to retained earnings 18.5 6.4 Number of shares 10 10 Dividends per share (in dollars) 2.97 4.08

SunTrust Telecom Inc.,I/S 2014 2013 2014 2013 (In millions of dollars) Assets Liabilities and Equity Accounts payable 11.2 9.6 Cash 5.6 5.3 Notes payable 74.1 69.5 Marketable securities 51.9 53 Accruals 28.1 27.5 Accounts receivable 56.2 49.9 Total current liabilities 113.4 106.6 Inventories 112.4 106 Total current assets 226.1 214.2 Long-term bonds 148.2 140.8 Preferred stock 37.1 35.4 Common stock (par plus paid-in-capital) 160 160 Net plant and equipment 397.5 375 Retained earnings 164.9 146.4 Common equity 324.9 306.4 Total assets 623.6 589.2 Total liabilities and equity 623.6 589.2

Explanation / Answer

growth rate 3% 20% Year 2013 2014 Year 2014 2015 2016 2017 2018 1) Net Income attributable to common shares 47.2 48.2 0 1 2 3 4     Net Capial Assets 375 397.5 FCFE/share 2.80 3.36 4.03 4.84 5.81 2) Net CAPEX 22.5 Continuing value@ the end of year 2017 193.536    Net Operating Assets 214.2 226.1 3) Net Operating Asset Investments 11.9 PV factors @15% 0.869565 0.756144 0.657516 0.5717    Net Financial Obligations 247.4 261.6 4) NetFNCE 14.2 PV of FCFEs 2.921738 3.04877261 3.18132541 5) Free Cash Flow for Common Equity 1)-2)-3)+4) 28 PV of Continuing Value 110.644531 6) # of shares 10 7)per share FCFE, 5) / 6) 2.8 Sum of PVs 119.80 (per share equity value)

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