Question

1.

You are valuing Soda City Inc. It has $100 million of debt, $90 million of cash, and 150 million shares outstanding. You estimate its cost of capital is 13.0%. You forecast that it will generate revenues of $700 million and $800 million over the next two years. Projected operating profit margin is 20%, tax rate is 30%, reinvestment rate is 20%, and terminal exit value multiple at the end of year 2 is 15. What is your estimate of its share price? Round to one decimal place. (Hint: Compute projected FCFF for years 1 and 2 based on info provided, compute terminal value using the exit multiple method, discount it all to find EV, walk the bridge to Equity, divide by number of shares outstanding.) Numeric Answer:

2

Answer 1

Free Cash Flow to Firm (FCFF) is derived using the following formula :-

FCFF = EBIT * (1-tax rate) + Depreciation - Fixed Capital Investment - Working Capital Investment

EBIT refers to Earnings before Interest and Taxes or Operating Profit.

Please Note that the Question does not provide any information regarding "Depreciation", "Fixed Capital Investment" and "Working Capital Investment" and hence, we are assuming them to be 0

Attaching the calculations and the formulas used :-

A Particulars Year 1 Year 2 Revenue Operating Margin Operating Profit/ EBIT Tax Rate EBIT * (1-tax rate) Depreciation Fixed Capital Investment Working Capital Investment 700 20% 140 30% 98 0.00 0.00 800 20% 160 30% 112 0.00 0.00 0.00 0.00 Free Cash Flow to Firm 98.00 112.00 Terminal Value at end of year 2 1,680.00 16 Cost of Capital Year Cash Flow PV @ 13% 98.00 2 112.00 2 1,680.00 13% PV of Cash Flows 0.88 86.73 0.78 87.71 0.78 1315.69 SUM 1490.12

В Particulars Year 1 Year 2 700 0.2 =C4*C5 Revenue Operating Margin Operating Profit/ EBIT Tax Rate EBIT * (1-tax rate) Depreciation Fixed Capital Investment Working Capital Investment 800 0.2 =D4*D5 0.3 =D6*(1-07) 0.3 =C6*(1-07) 0 0 Free Cash Flow to Firm =C8+C9-C10-C11 =D8+D9-D10-D11 Terminal Value at end of year 2 =D13*15 Cost of Capital Year Cash Flow =C13 =D13 =D15 0.13 PV @ 13% PV of Cash Flows =1/(1+$D$17)^B19 =C19*D19 =1/(1+$D$17) B20 =C20*D20 =1/(1+$D$17)^B21 =C21*D21 SUM =SUM(E19:E21)

Hence, Enterprise Value = 1490.12 mn

We know that,

Enterprise Value = Market Value of Debt + Market Value of Equity - Cash & Cash Equivalents

Plugging in known values we get :-

1490.12 = 100 + Market Value of Equity - 90

1490.12 - 10 = Market Value of Equity

Market Value of Equity = 1480.12 mn

No of shares outstanding = 150 mn

Hence, share price = ( 1480.12 / 150) = $9.87 or $9.9