Tight Rope Manufacturing firm earned a net profit margin of 10% on revenues of $
ID: 2796593 • Letter: T
Question
Tight Rope Manufacturing firm earned a net profit margin of 10% on revenues of $5 million this year. Fixed capital investment was $1 million, there was a long term sale of $0.5mn for which you received cash, and depreciation was $2 million. Working capital investment equals 15% of increment sales every year. Net income, fixed capital investment, depreciation, interest expense, and sales are expected to grow at 15% per year for the next six years. After six years, the growth in sales, net income, fixed capital investment, depreciation, and interest expense will decline to a stable 7% per year. The tax rate is 40%, and Tight Rope has 2 million shares of common stock outstanding and long-term debt paying 7.5% interest trading at its par value of $12 million. WACC is 13% during the high-growth stage and 9% during the stable stage.
(a) Calculate the value of the firm using FCFF model? (5 marks)
(b) Calculate its equity and price per share.? (5 marks)
Explanation / Answer
FCFF - Free Cash Flow to the Firm
FCFF = Net Income + Non- Cash Charges (Amortization/Depreciation) + Interest*(1-Tax Rate) - Fixed Capital Expenditure - Working Capital Expenditure
Net Income = 10%*5 million = 500,000
Non- Cash Charges = 2 million
Interest = 12 million * (1 -40%)
Fixed Capital Expenditure = 1 million
Working Capital Expenditure = 5 million *15%
FCFF = 500,000 +2,000,000 + 12,000,000*0.6 – 1,000,000 – 750,000
FCFF = 7,950,000
WACC = 13%
Growth Rate = 7%
(a)
Firm Value = FCFF /(WACC – r) = 7,950,000/(0.13 – 0.07) = $132.5 million
(b)
Equity Value = Firm Value – Debt Value = 132.5 – 12 = $120.5 million
Book Value per Share = Equity Value/Total Outstanding Share = 120.5/2 = $60.25
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