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Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250
Textbook Problem

CORPORATE VALUE MODEL Assume that today is December 31, 2018, and that the following information applies to Abner Airline:

  • After tax operating income [EBIT(1 – T)] for 2019 is expected to be $400 million.
  • The depreciation expense for 2019 is expected to be $140 million.
  • The capital expenditures for 2019 are expected to be $225 million.
  • No change is expected in net operating working capital.
  • The free cash flow expected to grow at a constant rate of 6% per year.
  • The required return on quity is 14%.
  • The WACC is 10%.
  • The firm has $200 million of non-operating assets.
  • The market value of the company’s dept is $3.875 billion.
  • 220 million shares of stock are outstanding.

Summary Introduction

To determine: The present stock price of the A airlines.

Introduction:

Stock valuation models consist of two methods:

  • Corporate valuation model
  • Discounted dividend model

Valuing the assets already owned by the investor is corporate valuation model. It is very flexible and better to utilize the companies who do not pay any dividends and to whose companies’ prediction of dividends are tough.

Explanation

Given information:

The EBIT is with tax is $400 million.

The depreciation is $140 million.

The capital expenditure is $225 million.

Growth rate is 0.06 and 0.10 for WACC.

Note: Determine the market value to calculate the price per stock.

The formula to compute the free cash flow:

Freecashflow=(EBIT(1T)+DepreciationCapitalexpenditureNet operating capital expenditure)

The formula to calculate the market value:

Marketvalue=FreecashflowWACCg

The formula to calculate the total market value:

Total market value=Market value+Non-operating assets

The formula to calculate the price per share:

Pricepershare=Totalmarket value of equityNumber of shares outstanding

Calculate the free cash flow:

Freecashflow=(EBIT(1T)+DepreciationCapitalexpenditureNet operating capital expenditure)=$400,000,000+$140,000,000$225,000,000$0=$315,000,000

Hence, the free cash flow is $315,000,000.

Compute the market value:

Marketvalue=FreecashflowWACCg=$315,000,0000

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