Page 281 - AFM Integrated Workbook STUDENT S18-J19

Business valuation

 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 free cash flow to equity and discounting to present
value using the cost of equity.

Solution

$m 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 = $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 = $1.57 per share.

269