Question

8. Corporate valuation model

The corporate valuation model, the price-to-earnings (P/E) multiple approach, and the economic value added (EVA) approach are some examples of valuation techniques. The corporate valuation model is similar to the dividend-based valuation that you’ve done in previous problems, but it focuses on a firm’s free cash flows (FCFs) instead of its dividends. Some firms don’t pay dividends, or their dividends are difficult to forecast. For that reason, some analysts use the corporate valuation model.

Sixty Second Avenue Inc. has an expected net operating profit after taxes, EBIT(1 – T), of $7,700 million in the coming year. In addition, the firm is expected to have net capital expenditures of $1,155 million, and net operating working capital (NOWC) is expected to increase by $40 million. How much free cash flow (FCF) is Sixty Second Avenue Inc. expected to generate over the next year?

a) $8,815 million

b) $6,505 million

c) $156,194 million

d) $6,585 million

Sixty Second Avenue Inc.’s FCFs are expected to grow at a constant rate of 3.54% per year in the future. The market value of Sixty Second Avenue Inc.’s outstanding debt is $41,345 million, and its preferred stocks’ value is $22,970 million. Sixty Second Avenue Inc. has 600 million shares of common stock outstanding, and its weighted average cost of capital (WACC) equals 10.62%.

Term	Value (Millions)
Total firm value
Intrinsic value of common equity
Intrinsic value per share

Using the preceding information and the FCF you calculated in the previous question, calculate the appropriate values in this table. Assume the firm has no nonoperating assets.

Answer 1

EBIT(1-T) = $7,700 million

Less: Net Capital Expenditure = $1,155 million

Increase in Net Operating Working capital = $40 million

Free cash flow = $6,505 million

i.e. b

Firm Value = Free cash flow next year/(WACC – growth rate)

= 6,505/(10.62%-3.54%)

= $91,878.53 million

Less: Value of debt = $41,345 million

Value of preferred Stock = 22,970 million

Value of Equity = $27,563.53 million

Number of shares = 600 million

Intrinsic value per share = $45.94