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Chapter 10

 Butler Co's financing costs are expected to stay constant each year in
the future.

 the marginal rate of tax is 28%, payable in the year in which the liability
arises.

 assume that book depreciation equals tax depreciation.

 Butler Co has 500 million shares in issue.

 the WACC of Butler Co is 9% and its cost of equity is 12%.

Required:

Calculate the value of the equity in Butler Co (in total and per share) by
forecasting future cash flows to equity and discounting them to present
value using cost of equity.

Solution

GBPm Year 1 Year 2 Year 3 etc
Sales (×1.03 × 1.05) 308.3 333.5 360.6
Cost of sales (×1.05) (126.9) (133.3) (140.0)
–––––– –––––– ––––––
Gross profit 181.4 200.2 220.6
Operating expenses (66.9) (66.9) (66.9)
Financing costs (10.0) (10.0) (10.0)
–––––– –––––– ––––––
Forecast profit before tax 104.5 123.3 143.7
Less Taxation (28%) (29.3) (34.5) (40.2)
Add back depreciation 12.3 12.3 12.3
Less Capital expenditure (15.0) (15.0) (15.0)
Less Working capital investment (2.0) (2.0) (2.0)
–––––– –––––– ––––––
Forecast cash flows to equity 70.5 84.1 98.8
–––––– –––––– ––––––
DF 12% 0.893 0.797 0.797/0.12
–––––– –––––– ––––––
Present value 63.0 67.0 656.2
–––––– –––––– ––––––

So the net present value = GBP 786.2m

This is the total value of the equity in Butler Co. With 500 million shares in
issue, this corresponds to a value of 786.2/500 = GBP 1.57 per share.

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