ABC’s earnings before interest taxes (EBIT) was $900,000 and depreciation was $100,000 in the year just ended, and it expects that this will grow by 5% per year forever. To make this happen, the firm will have to invest an amount equal to 20% of pretax cash flow (i.e., EBIT + Depreciation) each year. The tax rate is 35%. The appropriate market capitalization rate for the unleveraged cash flow is 10% per year (i.e., cost of capital ka = .10), and the firm currently has debt of $2 million outstanding. Ignore ABC’s interest expenses, change in debts, and change in net working capital.
(a) Given ABC’s next year EBIT of $945,000 and interest expenses of $0, the taxable income will be $945,000. Given the tax rate of 35%, compute the tax amount in the coming year.
(b) Given ABC’s next year EBIT of $945,000, depreciation of $105,000 and taxes computed in part (a), compute the operating cash flow (OCF) in the coming year using the formula: OCF = EBIT + Deprecation – Taxes in the coming year.
(c) Given ABC’s next year EBIT of $945,000 and depreciation of $105,000, its capital expenditure will be $210,000. What is the free cash flow for the firm (FCFF) in the coming year if ?NWC is zero? (FCFF = OCF – Capital expenditure – ?NWC).
(d) Use the free cash flow approach to compute the firm value.
(e) Given the firm value computed in part (d) and the value of debt outstanding of $2 million, compute the equity value in the coming year. (Equity value = firm value – debt value)
(f) If there are 6 million shares of common stocks outstanding. What is the stock price per share? (P0 = equity value / number of shares outstanding)