Question

Sora Industries has 64 million outstanding shares, $127 million in debt, $42 million in cash, and the following projected free cash flow for the next four years: Year 0 1 2 3 4 5 Earnings and FCF Forecast ($ million) 1 Sales 433.0 468.0 516.0 547.0 574.3 2 Growth vs. Prior Year 8.1% 10.3% 6.0% 5.0% 3 Cost of Goods Sold (313.6) (345.7) (366.5) (384.8) 4 Gross Profit 154.4 170.3 180.5 189.5 5 Selling, General, & Admin. (93.6) (103.2) (109.4) (114.9) 6 Depreciation (7.0) (7.5) (9.0) (9.5) 7 EBIT 53.8 59.6 62.1 65.2 8 Less: Income Tax at 40% (21.5) (23.8) (24.8) (26.1) 9 Plus: Depreciation 7.0 7.5 9.0 9.5 10 Less: Capital Expenditures (7.7) (10.0) (9.9) (10.4) 11 Less: Increase in NWC (6.3) (8.6) (5.6) (4.9) 12 Free Cash Flow 25.3 24.6 30.8 33.3 a. Suppose Sora's revenue and free cash flow are expected to grow at a 5.2% rate beyond year four. If Sora's weighted average cost of capital is 10.0%, what is the value of Sora stock based on this information? b. Sora's cost of goods sold was assumed to be 67% of sales. If its cost of goods sold is actually 70% of sales, how would the estimate of the stock's value change? c. Return to the assumptions of part (a) and suppose Sora can maintain its cost of goods sold at 67% of sales. However, the firm reduces its selling, general, and administrative expenses from 20% of sales to 16% of sales. What stock price would you estimate now? (Assume no other expenses, except taxes, are affected.) d. Sora's net working capital needs were estimated to be 18% of sales (their current level in year zero). If Sora can reduce this requirement to 12% of sales starting in year 1, but all other assumptions are as in (a), what stock price do you estimate for Sora? (Hint: This change will have the largest impact on Sora's free cash flow in year 1.)

Answer 1

A C D E F 1 Part A 1 2 3 4 433 3 Earnings and FCF Forecast 4 Sales 5 Growth vs. Prior Year 6 COGS 7 Gross Profit 3 Selling, General and Adm 9 Depreciation O EBIT 1 Less: Income Tax 40% 2 Plus: Depreciation 3 Less: Capital Expenditure 4 Less: Increase in NWC 5 Free Cash Flow 468 516 547 574.3 8.10% 10.30% 6.00% 5.00% -313.6 -345.7 -366.5 -384.8 154.4 170.3 180.5 189.5 -93.6 -103.2 -109.4 -114.9 -7 -7.5 -9 -9.5 53.8 59.6 62.1 65.1 -21.52 -23.84 -24.84 -26.04 7 7.5 9 9.5 -7.7 -10 -9.9 -10.4 -6.3 -8.6 -5.6 -4.9 25.28 24.66 30.76 33.26 22.98182 20.38017 23.11044 497.8815 7 WACC 8 growth rate 10% 5.20% 9 20 Free Cash Flow 21 Debt ($) 22 shares outstanding 564.4 million 127 million 64 24 Value of Stock 6.83

А C D E F G H 1 Part B 1 23 2 4 433 3 Earnings and FCF Forecast 4 Sales 5 Growth vs. Prior Year 6 COGS 7 Gross Profit 8 Selling, General and Adm 9 Depreciation 10 EBIT 11 Less: Income Tax 40% 12 Plus: Depreciation 13 Less: Capital Expenditure 14 Less: Increase in NWC 15 Free Cash Flow 468 516 547 574.3 8.10% 10.30% 6.00% 5.00% -327.6 -361.2 -382.9 -402.01 140.4 154.8 164.1 172.29 -93.6 -103.2 -109.4 -114.9 -7.5 -9.5 39.8 44.1 45.7 47.89 -15.92 -17.64 -18.28 -19.156 7 7.5 9 9.5 -7.7 -10 -9.9 -10.4 -6.3 -8.6 -5.6 -4.9 16.88 15.36 20.92 22.934 15.34545 12.69421 15.71751 343.3077 16 17 WACC 18 growth rate 10% 5.20% 20 Free Cash Flow 21 Debt ($) 22 shares outstanding 387.1 million 127 million 64 24 Value of stock 4.06 25 Value of stock will decrease by increasing COGS by 70%

Part C 0 1 2 3 433 : Earnings and FCF Forecast = Sales Growth vs. Prior Year COGS Gross Profit - Selling, General and Adm Depreciation o EBIT 1 Less: Income Tax 40% 2 Plus: Depreciation 3 Less: Capital Expenditure 4 Less: Increase in NWC 5 Free Cash Flow 468 8.10% -313.56 154.44 -74.88 -7 72.56 -29.024 7 -7.7 -6.3 36.536 33.2145 516 547 574.3 10.30% 6.00% 5.00% -345.72 -366.49 -384.78 170.28 180.51 189.519 -82.56 -87.52 -91.888 -7.5 -9 -9.5 80.22 83.99 88.131 -32.088 33.596 35.252 7.5 9 9.5 -10 -9.9 -10.4 -8.6 -5.6 -4.9 37.032 43.894 47.0786 30.605 32.9782 704.737 7 WACC 3 growth rate 10% 5.20% PV of Free Cash Flow 1 Debt ($) 2 shares outstanding 801.5 million 127 million 64 4 Value of stock 10.5 5

Part D 433 Earnings and FCF Forecast Sales Growth vs. Prior Year COGS Gross Profit Selling, General and Adm e Depreciation o EBIT 1 Less: Income Tax 40% 2 Plus: Depreciation 3 Less: Capital Expenditure 4 Less: Increase in NWC 5 Free Cash Flow 468 8.10% -313.56 154.44 -74.88 -7 72.56 -29.024 7 -7.7 -21.78 21.056 21.056 516 10.30% -345.72 170.28 -82.56 -7.5 80.22 -32.088 7.5 -10 -5.76 39.872 39.872 547 574.3 6.00% 5.00% -366.49 -384.781 180.51 189.519 -87.52 -91.888 -9 -9.5 83.99 88.131 -33.596 -35.2524 9 9.5 -9.9 -10.4 -3.72 -3.276 45.774 48.7026 45.774 729.0476 7 WACC 8 growth rate 10% 5.20% 0 PV of Free Cash Flow 1 Debt ($) 2 shares outstanding 835.7 127 64 4 Value of stock 11.1

1 Part A 0 1 2 3 4 433 B Earnings and FCF Forecast 4 Sales 5 Growth vs. Prior Year 5 COGS 7 Gross Profit 3 Selling, General and Adm Depreciation O EBIT 1 Less: Income Tax 40% 2 Plus: Depreciation 3 Less: Capital Expenditure 4 Less: Increase in NWC 5 Free Cash Flow 6 Calculating PV 7 WACC 8 growth rate 468 516 547 574.3 8.10% 10.30% 6.00% 5.00% -313.6 -345.7 -366.5 -384.8 154.4 170.3 180.5 189.5 -93.6 -103.2 -109.4 - 114.9 -7 -7.5 -9 -9.5 53.8 59.6 62.1 65.1 -21.52 -23.84 -24.84 -26.04 7.5 9 -7.7 -10 -9.9 -10.4 -6.3 -8.6 -5.6 -4.9 25.28 24.66 30.76 33.26| 22.98182 20.38017 23.11044|=F15*(1+B18)/(B17-B18)/(1+B17)^4 1 9.5 10% 5.20% O PV of Free Cash Flow 21 Debt ($) -2 shares outstanding 564.4 million 127 million 64 4 Value of Stock 6.83

R 1 Part A 0 1 2 3 4 433 3 Earnings and FCF Forecast Sales 5 Growth vs. Prior Year 5 COGS 7 Gross Profit 3 Selling, General and Adm Depreciation O EBIT 1 Less: Income Tax 40% 2 Plus: Depreciation 3 Less: Capital Expenditure 4 Less: Increase in NWC 5 Free Cash Flow 6 Calculating PV 7 WACC 8 growth rate 468 516 547 574.3 8.10% 10.30% 5.00% 5.00% -313.6 -345.7 -366.5 -384.8 154.4 170.3 180.5 189.5 -93.6 -103.2 -109.4 -114.9 -7.5 -9.5 53.8 59.6 62.1 65.1 -21.52 -23.84 -24.84 -26.04 7 7.5 9 9.5 -7.7 -10 -9.9 -10.4 -6.3 -8.6 -5.6 -4.9 25.28 24.66 30.76 33.26 22.98182 20.38017 23.11044 497.8815| 10% 5.20% OPV of Free Cash Flow 1 Debt ($) 2 shares outstanding =SUM(B16:F16) SUM(number1, [number2], ...) 64 4 Value of Stock 6.83

Α. B C D E F G H 1 Part A 0 1 2 3 4 433 -7 -9.5 B Earnings and FCF Forecast 4 Sales 5 Growth vs. Prior Year 5 COGS 7 Gross Profit 3 Selling, General and Adm Depreciation O EBIT 1 Less: Income Tax 40% 2 Plus: Depreciation 3 Less: Capital Expenditure 4 Less: Increase in NWC 5 Free Cash Flow 6 Calculating PV 7 WACC 8 growth rate 468 516 547 574.3 8.10% 10.30% 6.00% 5.00% -313.6 -345.7 -366.5 -384.8 154.4 170.3 180.5 189.5 -93.6 -103.2 -109.4 -114.9 -7.5 -9 53.8 59.6 62.1 65.1 -21.52 -23.84 -24.84 -26.04 7 7.5 9 9.5 -7.7 -10 -9.9 -10.4 -6.3 -8.6 -5.6 -4.9 25.28 24.66 30.76 33.26 22.98182 20.38017 23.11044 497.8815 10% 5.20% O PV of Free Cash Flow 21 Debt ($) -2 shares outstanding 564.4 million 127 million 64 -3 -4 Value of Stock =(B20-B21)/B22

A B C D E F G H I J K 1 Part B 0 1 2 3 4 3 Earnings and FCF Forecast 4 Sales 5 Growth vs. Prior Year 6 COGS 7 Gross Profit 8 Selling, General and Adm 9 Depreciation 10 EBIT 11 Less: Income Tax 40% 12 Plus: Depreciation 13 Less: Capital Expenditure 14 Less: Increase in NWC 15 Free Cash Flow 433 468] 516 547 574.3 8.10% 10.30% 5.00% 5.00% =-C4*70% -382.9 -402.01 140.4 154.8 164.1 172.29 -93.6 -103.2 -109.4 -114.9 -7 -7.5 -9 -9.5 39.8 44.1 45.7 47.89 -15.92 -17.64 -18.28 -19.156 7 7.5 9 9.5 -7.7 -10 -9.9 -10.4 -6.3 -8.6 -5.6 -4.9 16.88 15.36 20.92 22.934 15.34545 12.69421 15.71751 343.3077 16 17 WACC 18 growth rate 10% 5.20% 19 20 Free Cash Flow 21 Debt ($) 22 shares outstanding 387.1 million 127 million 64 23 24 Value of stock 4.06 25 Value of stock will decrease by increasing COGS by 70%

c o E F G H 1 2 3 4 468 8.10% 313.56 | B 1 Part C 2 0 3 Earnings and FCF Forecast 4 Sales 433 5 Growth vs. Prior Year 6 COGS 7 Gross Profit 8 Selling, General and Adm 9 Depreciation 10 EBIT 11 Less: Income Tax 40% 12 Plus: Depreciation 13 Less: Capital Expenditure 14 Less: Increase in NWC 15 Free Cash Flow 16 17 WACC 10% 18 growth rate 5.20% --16%*C4 -77 72.56 -29.024 7 -7.7 -6.3 36.536 33.2145 516 547 574.3 10.30% 6.00% 5.00% 345.72 -366.49 -384.78 180.51 189.519 -87.52 -91.888 -7.5 -9 -9.5 80.22 83.99 88.131 -32.088 -33.596 -35.252 7.5 9 9.5 -10 -9.9 -10.4 -8.6 -5.6 -4.9 37.032 43.894 47.0786 30.605 32.9782 704.737 19 801.5 million 127 million 64 20 PV of Free Cash Flow 21 Debt ($) 22 shares outstanding 23 24 Value of stock 25 10.5 28

A 1 Part D 3 Earnings and FCF Forecast 4. Sales 5 Growth vs. Prior Year 6 COGS 7 Gross Profit 8 Selling, General and Adm 9 Depreciation 10 EBIT 11 Less: Income Tax 40% 12 Plus: Depreciation 13 Less: Capital Expenditure 14 Less: Increase in NWC 15 Free Cash Flow -7 4331 468 516 8.10% 10.30% -313.56 -345.72 154.44 170.28 -74.88 -82.56 -7.5 72.56 80.22 -29.024 -32.088 7 7.5 -7.7 -10 =(C4*12%-B4*18%) 21.056 39.872 21.056 39.872 10% 5.20% 547 574.3 6.00% 5.00% -366.49 -384.781 180.51 189.519 -87.52 -91.888 -9 -9.5 83.99 88.131 -33.596 -35.2524 9 9.5 -9.9 -10.4 -3.72 -3.276 45.774 48.7026 45.774 729.0476 6 17 WACC 18 growth rate 20 PV of Free Cash Flow 21 Debt ($) 22 shares outstanding 835.7 127 24 Value of stock 11.1