   Chapter 9, Problem 20P ### Fundamentals of Financial Manageme...

9th Edition
Eugene F. Brigham + 1 other
ISBN: 9781305635937

#### Solutions

Chapter
Section ### Fundamentals of Financial Manageme...

9th Edition
Eugene F. Brigham + 1 other
ISBN: 9781305635937
Textbook Problem
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# CORPORATE VALUE MODEL Assume that today is December 31, 2016, and that the following information applies to Abner Airlines: After-tax operating income [EBIT(1 – T)] for 2017 is expected to be $400 million. The depreciation expense for 2017 is expected to be$140 million. The capital expenditures for 2017 are expected to be $225 million. No change is expected in net operating working capital. The free cash flow is expected to grow at a constant rate of 6% per year. The required return on equity is 14%. The WACC is 10%. The market value of the company’s debt is$3,875 billion. 200 million shares of stock are outstanding. Using the corporate valuation model approach, what should be the company’s stock price today?

Summary Introduction

To calculate: The present value of estimated free cash flow.

Introduction:

Corporate Value Model:

The model that evaluates a firm on the basis of its future operations and the results of those operations is called corporate valuation model. It is a useful tool to analyze a firm’s stock for investment purposes.

Explanation

Given information:

The EBIT is with tax is $400 million. The depreciation is$140 million.

The capital expenditure is $225 million. The formula to calculate the free cash flow, Freecashflow=EBIT(1T)+DepreciationCapitalexpenditure Substitute$400,000,000 for EBIT(1+T), $140,000,000 for depreciation and$225,000,000 for capital expenditure.

Freecashflow=$400,000,000+$140,000,000$225,000,000=$315,000,000

Compute the intrinsic value

The items required for the calculation of intrinsic value are free cash flow, growth rate, and WACC.

The free cash flow is $315 million. (Calculated in part a) The growth rate is 6% or 0.06. The WACC is 10% or 0.10. The formula to calculate the intrinsic value, Intrinsicvalue=FreecashflowWACCg Where, • WACC is the weighted average cost of capital. • G for growth rate. Substitute$315,000,000 for free cash flows, 0.06 for growth rate and 0.10 for WACC.

Intrinsicvalue=\$315,000,0000

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