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Fundamentals of Financial Manageme...

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

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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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