Question

Sora Industries has 6868 million outstanding shares, $120 million in debt, $49 million in cash, and the following projected free cash flow for the next four years :

		Year	0	1	2	3	4
Earning & FCF Forecast ($millions)
1	Sales		433	468	516	547	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	7.5	9	9.5
10	Less: Capital Expenditures			(7.7)	(10.0)	(9.9)	(10.4)
11	Less: Increases 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 4.4% rate beyond year 4. If Sora's weighted average cost of capital is 11.0% , what is the value of Sora's 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. Let's return to the assumptions of part (a ) and suppose Sora can maintain its cost of goods sold at 67% of sales. However, now suppose Sora 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 (which is their current level in year 0). If Sora can reduce this requirement to 12% of sales starting in year 1, but all other assumptions remain as in part (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

Case (a)

Step 1: Calculating Terminal Value (TV)

TV =

FCFt = last year's projected Free Cash Flow = $ 33.3 million or 33.3

g = expected growth rate = 4.4% or 0.044

r = cost of capital = 11% or 0.11

TV = $AQiubmWG+5xx0jlnLnPqMuffusAF+EIIADs=$

TV =

TV = 526.7455

Step 2: Calculating Present Value of Terminal Value (PV_TV)

PV_{TV =}

r = Cost of Capital = 11% or 0.11%

t = time period = 4

PV_{TV =} = 346.9835

Step 3: Calculating Present Value of Projected Free Cash Flows(PV_FCF)

PV_FCF =

C_i = Projected Free Cash Flows

r = Cost of Capital = 11% or 0.11

PV = + $16G8MtEayxsOhqLSgCBPlC4cV0GNEgIAOw==$ + + = 87.22

Step 4: Calculating Net Present Value of Firm(PV_F)

PV_{F =} PV_{TV +} PV_{FCF =} 346.9835 +87.22 =$ 434.2035 million

Step 5: Subtracting Value of Debt from Net Present Value of Firm

Value of Debt = $ 120 million

Net Present Value of Firm = $ 434.2035

434.2035 - 120 = $ 314.2035 million = Value of Equity

Step 5: Calculating Value of Stock

Value of Stock = Value of Equity / Number of Equity Shares Outstanding

Value of Stock = 314.2035 / 6868 = $ 0.045749

Case (b)

New FCF statement after adjusting COGS being 70% of Sales

		0	1	2	3	4
1	Sales	433.00	468.00	516.00	547.00	574.30
3	Cost of Goods Sold		-327.60	-361.20	-382.90	-402.01
4	Gross Profit		140.40	154.80	164.10	172.29
5	Selling, General & Admin.		-93.60	-103.20	-109.40	-114.90
6	Depreciation		-7.00	-7.50	-9.00	-9.50
7	EBIT		39.80	44.10	45.70	47.89
8	Less: Income tax at 40%		-15.92	-17.64	-18.28	-19.16
9	Plus: Depreciation		7.00	7.50	9.00	9.50
10	Less: Capital Expenditures		-7.70	-10.00	-9.90	-10.40
11	Less: Increases in NWC		-6.30	-8.60	-5.60	-4.90
12	Free Cash Flow		16.88	15.36	20.92	22.93

Using case (a) approach and using new FCF,

Terminal Value = 362.7109

Present Value of Terminal Value = 238.9289

Present Value of Projected Free Cash Flows = 58.08

Net Present Value of Firm = 297.01

Subtracting Value of Debt from Net Present Value of Firm = 177.01

Value of Stock = $ 0.025772

Change in Stock Value in comparison to case (a) = 0.025772 - 0.045749 = -0.019976 or -43.66%

Case (c)

New FCF statement after adjusting selling, general, and administrative expenses being 16% of sales

		0	1	2	3	4
1	Sales	433.00	468.00	516.00	547.00	574.30
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.		-74.88	-82.56	-87.52	-91.888
6	Depreciation		-7	-7.5	-9	-9.5
7	EBIT		72.52	80.24	83.98	88.112
8	Less: Income tax at 40%		-29.008	-32.096	-33.592	-35.245
9	Plus: Depreciation		7	7.5	9	9.5
10	Less: Capital Expenditures		-7.7	-10	-9.9	-10.4
11	Less: Increases in NWC		-6.3	-8.6	-5.6	-4.9
12	Free Cash Flow		36.512	37.044	43.888	47.0672

Using case (a) approach and using new FCF,

Terminal Value = 744.5175

Present Value of Terminal Value = 490.4368

Present Value of Projected Free Cash Flows = 126.05

Net Present Value of Firm = 616.49

Subtracting Value of Debt from Net Present Value of Firm = 496.49

Value of Stock = $ 0.072290

Change in Stock Value in comparison to case (a) = 0.072290- 0.045749 = 0.026541 or 58.01%