Question

BBB had EPS of $3.15 in 2019 and expects EPS to increase by 20% in 2020. Earnings per share are expected to grow at a decreasing rate for the following five years, as shown in the following table. Growth rate for EPS Net capital expenditures per share 2020 20% $4.00 2021 17% $4.00 2022 14% $3.50 2023 11% $3.00 2024 8% $2.50 2025 4% $1.50 In 2025, the EPS growth rate will be 4% and is expected to stay at that rate thereafter. Net capital expenditures (capital expenditures minus depreciation) are $5.00 per share in 2019 and then follow the pattern predicted in the table. In 2025, net capital expenditures are expected to be $1.50 and will then grow at 5% percent annually. The investment in working capital parallels the increase in net capital expenditures and is predicted to equal 25% of net capital expenditures each year. In 2025, investment in working capital will be $0.375 and is predicted to grow at 5% thereafter. BBB will use debt financing to fund 45% of net capital expenditures and the investment in working capital. The current market conditions offers a risk-free rate of 1%, and equity risk premium of 5.5%, and an adjusted beta of 1.20. The cost of equity for BBB is 5.44%. 1. Estimate the value of an Invest share using a two-stage FCFE valuation approach.

Answer 1

We need to use MS excel for these calculations

Given below is the excel solution followed by an explanation

Year 2019 2020 2021 2022 2023 2024 2025 3.151 EPS Growth rate of EPS Terminal EPS 3.78 20% 4.42 17% 5.04 14% 5.60 11% 6.04 8% 6.29 49 157.146 4. 4 3.5 3 Capex Terminal Capex 2.5 1.5 301 0.625/ 0.375 - Net Working Capital Terminal WC 0.875 0.75 FCFE -1.22 -0.58 0.67 1.85 2.92 124.06 Ke 0.076 PV of Cash flow -1.13 -0.50 0.54 1.38 2.02 79.94 Value 82.24

The forecast for Capex, EPS and Working capital is as per the questionNow,

The terminal value is calculated separately because the terminal growth rate for EPS is 4% and the other two is 5%

The FCFE = EPS - WC - Capex for that year ( In last year terminal values are also used)

The Ke is calculated using CAPM

Ke = 1 + 1.2*(5.5) = 7.6%

To find PV we discounted using Ke = 7.6%

The value is the sum of all PV

Try the same on excel and comment you need any further explanation