Question

Sora Industries has 70 million outstanding shares, $121 million in debt, $53 million in cash, and the following projected free cash flow for the next four years:

Answer 1

Solution:

Based on the above figures, we can calculate the present value of Free cash flows for Year 1-4 at the discount rate of 10%, WACC, calculation

Present Value of Cash flow during explicit period ( 1-4 year)

Particulars	Years
	1	2	3	4
Free Cash Flows ( In $ Million)	25.3	24.6	30.8	33.3
Discounting factor @ 10%	0.909	0.826	0.751	0.683
Discounted Free Cash flows ( In $ Million)	22.99	20.31	23.13	22.74
Discounted Value ( In $ Million)	89.17

Discounted Cash Flow at Continuing Value = [Free Cash Flow at 4th year * (1+ growth) / cost of capital - growth ] * Discounting factor at 4th year, here growth is 4.7% rate beyond 4 years.

[33.33 * (1+ 0.047) / 0.10-0.047] * 0.683

=[34.89/0.053] * 0.683

=658.30 * 0.683

= 449.62

Present Value Cash Flow at Continuing Value = $ 449.62 million

Value of Equity

Sl No	Particulars	$ Million
a)	Present Value of Cash flow during explicit period	89.17
b)	Present Value Cash Flow at Continuing Value	449.62
c)	Value of firm (a+b)	538.79
d)	Value of Debt ( given)	121
e)	Value of Equity ( c-d)	417.79
f)	No of outstanding Shares ( given) (nos)	70
g)	Value of each Stock ( e / f) ( not in million)	5.96

Value of each Stock = $ 5.96

b)

Estimate of Change in Value of Stock, by the change in COGS from 67 % of sales to 70 % of sales, therefore increase in COGS by 3% of sales , that is ( 70-67) %, Now calculating Present Value of Cash flow during explicit period and Present Value Cash Flow at Continuing Value.

Present Value of Cash flow during explicit period (1-4 years)

Particulars	Years
	1	2	3	4
Free Cash Flows ( In $ Million)	25.3	24.6	30.8	33.3
Less: Increase in COGS of 3 % of Sales ( In $ Million) ( Notes)	14.04	15.48	16.41	17.22
Add: Tax Savings on Additional COGS	5.61	6.19	6.56	6.88
Adjusted Free Cash Flows ( In $ Million)	16.87	15.31	20.95	22.96
Discounting factor @ 10%	0.909	0.826	0.751	0.683
Discounted Free Cash flows ( In $ Million)	15.33	12.64	15.73	15.68
Present Value of Cash flow during explicit period	59.39

Notes

Particulars	Years
	1	2	3	4
Sales ( In $ million)	468	516	547	574.3
Increase in COGS , 3% of Sales ( In $ million)	14.04	15.48	16.41	17.22
Tax Savings of 40% of Increase in COGS ( In $ million)	5.61	6.19	6.56	6.88

Discounted Cash Flow at Continuing Value = [Free Cash Flow at 4th year * (1+ growth) / cost of capital - growth ] * Discounting factor at 4th year, here growth is 4.7% rate beyond 4 years.

[ 22.96* (1+ 0.047) / 0.10-0.047] * 0.683

=[24.03/0.053] * 0.683

=453.56 * 0.683

= 309.78

Present Value Cash Flow at Continuing Value = $ 309.78 million

Value of Equity

Sl No	Particulars	$ Million
a)	Present Value of Cash flow during explicit period	59.39
b)	Present Value Cash Flow at Continuing Value	309.78
c)	Value of firm (a+b)	369.17
d)	Value of Debt ( given)	121
e)	Value of Equity ( c-d)	248.17
f)	No of outstanding Shares ( given) (nos)	70
g)	Value of each Stock ( e / f) ( not in million)	3.54

Value of each stock = $3.54

The Change in stock = Stock Price before change in COGS - Stock Price after change in COGS

= $ 5.96 - $ 3.54 = $ 2.42, therefore there is decrease in stock price by $ 2.42 in each stock.

c) The selling , general & Administrative Expenses changes from 20% to 16 % of sales

Estimate of Change in Value of Stock, by the change in Selling, gen & Admin Expenses from 20% of sales to 16 % of sales, therefore decrease in selling , general & Administrative Expenses by 4% of sales , that is ( 20-16) %.

Now calculating Present Value of Cash flow during explicit period and Present Value Cash Flow at Continuing Value are as :

Present Value of Cash flow during explicit period (1-4 years)

Particulars	Years
	1	2	3	4
Free Cash Flows ( In $ Million)	25.3	24.6	30.8	33.3
Add: Decrease in selling,general & Administrative Expenses by 4% of sales ( In $ Million) ( Notes)	18.72	20.64	21.88	22.97
Less: Tax Expenses on Decrease in selling,general & Administrative Expenses ( In $ Million) ( Notes)	7.48	8.25	8.75	9.18
Adjusted Free Cash Flows ( In $ Million)	36.54	36.99	43.93	47.09
Discounting factor @ 10%	0.909	0.826	0.751	0.683
Discounted Free Cash flows ( In $ Million)	33.21	30.55	32.99	32.16
Present Value of Cash flow during explicit period	128.92

Notes

Particulars	Years
	1	2	3	4
Sales ( In $ million)	468	516	547	574.3
Decrease in selling,general & Administrative Expenses by 4% of sales ( In $ million)	18.72	20.64	21.88	22.97
Tax Expenses of 40% of Decrease in selling,general & Administrative Expenses  ( In $ million)	7.48	8.25	8.75	9.18

Discounted Cash Flow at Continuing Value = [Free Cash Flow at 4th year * (1+ growth) / cost of capital - growth ] * Discounting factor at 4th year, here growth is 4.7% rate beyond 4 years.

[ 47.09* (1+ 0.047) / 0.10-0.047] * 0.683

=[49.30/0.053] * 0.683

=930.24 * 0.683

= 635.36

Present Value Cash Flow at Continuing Value = $ 635.36 million

Value of Equity

Sl No	Particulars	$ Million
a)	Present Value of Cash flow during explicit period	128.92
b)	Present Value Cash Flow at Continuing Value	635.36
c)	Value of firm (a+b)	764.28
d)	Value of Debt ( given)	121
e)	Value of Equity ( c-d)	643.28
f)	No of outstanding Shares ( given) (nos)	70
g)	Value of each Stock ( e / f) ( not in million)	9.18

Value of each Stock = $9.18

The Change in stock = Stock Price after change in COGS - Stock Price before change in COGS

= $ 9.18 - $ 5.96 = $ 3.22, therefore there is increase in stock price by $ 3.22 in each stock.

d) Change in Working Capital

The Net Working Capital at Year 0 is 18 % of Sales in Year 0, = $ 433*18 %= $ 77.94

Year 1

Present Net Working Capital in Year 1 is 77.94+6.3 =$ 84.24 million, this is 18 % of the sales in year 1

(84.24 / 468 )*100

New Working Capital is 12% of Sales in Year 1 , therefore new Working Capital is 468 * 12% = $56.16 million.

Therefore Reduction in Working Capital = $ 84.24 million - $ 56.16 million = $28.08 million

But the Impact from past year from Net Working Capital is $ 77.94 -$56.16 million = $21.78 million

Similarly, we can find the Net working Capital changes in the rest of the years

Particulars	Year1	Year2	Year3	Year4
Opening Present Working Capital is ( In $ million)	77.94	84.24	92.84	98.44
Increase in Working Capital ( In $ million)	6.3	8.6	5.6	4.9
Present Working Capital ( In $ million)	84.24	92.84	98.44	103.34
New Working Capital ( 12 % of Sales) (a) ( In $ million)	56.16	61.92	65.64	68.91
Past Working Capital (b) ( In $ million)	77.94	56.16	61.92	65.64
Increase/ ( Decrease) in Working Capital (a-b) ( In $ million)	(21.78)	5.76	3.72	3.27

Putting the Impact of Changes in Working Capital in Free Cash Flows.

Particulars	Year1	Year2	Year3	Year4
Free Cash Flows ( In $ Million)	25.3	24.6	30.8	33.3
Add: Increase in Working Capital ( In $ Million)	6.3	8.6	5.6	4.9
Free Cash Flows before Working Capital Changes ( In $ Million)	31.6	33.2	36.4	38.2
Add: Decrease in Working Capital ( In $ Million) (as computed from above)	21.78	-	-	-
Less: Increase in Working Capital ( In $ Million) (as computed from above)	-	5.76	3.72	3.27
Free Cash Flows ( In $ Million)	53.38	27.44	32.68	34.93
Discounting factor @ 10%	0.909	0.826	0.751	0.683
Discounted Free Cash flows ( In $ Million)	48.52	22.66	24.54	23.85
Present Value of Cash flow during explicit period ( In $ Million)	119.58

Present Value of Cash flow during explicit period = $ 119.58 million

Discounted Cash Flow at Continuing Value = [Free Cash Flow at 4th year * (1+ growth) / cost of capital - growth ] * Discounting factor at 4th year, here growth is 4.7% rate beyond 4 years.

[ 34.93* (1+ 0.047) / 0.10-0.047] * 0.683

=[36.57/0.053] * 0.683

=690.03 * 0.683

= 471.29

Present Value Cash Flow at Continuing Value = $ 471.29 million

Value of Equity

Sl No	Particulars	$ Million
a)	Present Value of Cash flow during explicit period ( In $ Million)	119.58
b)	Present Value Cash Flow at Continuing Value ( In $ Million)	471.29
c)	Value of firm (a+b) ( In $ Million)	590.87
d)	Value of Debt ( given) ( In $ Million)	121
e)	Value of Equity ( c-d) ( In $ Million)	469.87
f)	No of outstanding Shares ( given) (nos)	70
g)	Value of each Stock ( e / f) ( not in million)	6.71

Value of each Stock = $6.71

The Change in stock = Stock Price after change in COGS - Stock Price before change in COGS

= $ 6.71 - $ 5.96 = $ 0.75, therefore there is increase in stock price by $ 0.75 in each stock.