The relevant stock price table lists out the calculated prices given a range of exit multiples and discount rates or WACC. Three cash flow exit multiples are used in the table (14x, 15x and 16x). At the same time, the discount rate which in essence is the implied WACC of Interco ranges from 10% to 14%. As a result of these assumptions, twelve different prices are obtained. The starting point of the calculations incorporates the formulation of free cash flows for the next ten years. Free cash flow can be computed by inputting the following formula: The EBIT is calculated by applying the following accounting equation: In the current case, the sales are projected to grow at a consistent annual rate of 7.2% for the span of next ten years. One of the most critical assumptions or information alters the nature of FCF calculations to a large extent.
· Stock Price
· Valuation at 14x
· Valuation at 14x (2)
· Valuation at 15x
· Valuation at 15x (2)
· Valuation at 16x
· Valuation at 16x (2)
· Reconstrcuted Table
· Table for New Assumptions
· Growth Rate computation
1. I would like you to re-‐construct the stock price table obtained by the investment bankers in the lower right corner of exhibit 12 under various assumptions on discount rate and terminal multiple.
2. Now suppose cash flows occur continuously during the year. We can model this by assuming that cash flows occur not at the end of the year but in the middle of the year. How will your share price estimates change under the alternate assumption?
3. Continuing value can also be obtained from assuming that FCF will grow at a constant rate from 1999 onwards. Assume that the firm’s cash flows will grow at a rate g. For the given discount rates in exhibit 12, what growth rates (1999 onwards) are implied by the various terminal multiples?
4. Assume that the beta of existing equity is 1.2. From exhibit 14, notice that the 10-‐year risk free rate is 9.01% and the yield on 10-‐yr AAA corporate debt is 9.5%. Use 5% as the market premium [E(Rm) – Rf]. Use stock price before the offer to obtain market value of equity, 318.5 million as the market value of debt and 41% as the tax rate to calculate the WACC for the existing firm. Now use Miles-‐Ezzel formula used in class to back out the unlevered cost of capital for Interco. Remember all your inputs should be changeable.
5. Examine the appropriateness of the assumptions underlying 12. The second panel in the provided spreadsheet might be useful here. It is a comparison of the assumptions in Exhibit 12 with historical operating results. These results are described in Exhibits 6-‐8.