Fincher Manufacturing has projected sales of $146.4 million next year. Costs are

ID: 2759507 • Letter: F

Question

Fincher Manufacturing has projected sales of $146.4 million next year. Costs are expected to be $81.7 million and net investment is expected to be $15.7 million. Each of these values is expected to grow at 15 percent the following year, with the growth rate declining by 2 percent per year until the growth rate reaches 7 percent, where it is expected to remain indefinitely. There are 6.2 million shares of stock outstanding and investors require a return of 14 percent return on the company’s stock. The corporate tax rate is 39 percent. a. What is your estimate of the current stock price? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Share price $ b. Suppose instead that you estimate the terminal value of the company using a PE multiple. The industry PE multiple is 10. What is your new estimate of the company’s stock price? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Share price $

Explanation / Answer

Sales

$146.4

Less: Cost

$81.7

Less: Net Investment

$15.7

EBT

$49

Less: Tax @ 39%

$19.11

PAT

$29.89

All Values are in millions.

EPS = $29.89 millions / 6.2 millions = $4.82

Now, as no information is given regarding the dividend payout ratio, we assume that all earnings are paid back as dividends. So, the dividend in year 1 is $4.82

Year

Dividend in previous year

Growth Rate

Current Dividend(Dividend in previous year*(1+Growth Rate)

$4.82

15%

$5.54

13%

$6.26

11%

$6.95

$7.58

Cost of Equity(Ke) = 14%

Present value of dividends = [($4.82)/(1+0.14)1] + [($5.54)/(1+0.14)2] + [($6.26)/(1+0.14)3] + ($6.95)/(1+0.14)4] + [($7.58)/(1+0.14)5] = $20.76

Terminal Value of Stock = [Dividend in Year 5*(1+ Long Term Growth)] / Ke – G
= [$7.58*(1+0.07)]/[0.14-0.07] = $115.86

Present Value of terminal value = $115.86/(1.14)5 = $60.18

Value of the stock = $20.76 + $60.18 = $80.94

b. Share price using PE multiple = EPS x PE Multiple
= $7.58 x 10 = $75.80