Question

Sora Industries has 70 million outstanding shares, $121 million in debt, $53 million in cash, and the following projected fre433.0 Earnings and FCF Forecast ($ million) 1 Sales 2 Growth vs. Prior Year 3 Cost of Goods Sold 4 Gross Profit 5 Selling, Gea. Suppose Soras revenue and free cash flow are expected to grow at a 4.7% rate beyond year four. If Soras weighted average

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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.

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