ABC develops computer products for consumers in Australia. In June 2014, a team of analysts issued a research report that valued ABC’s stock at $8.46 per share, compared to the then-current market price of $11. The research report’s discounted cash flow valuation table is reproduced below. The 2014 figures are as reported by ABC, but the 2015 through 2022 figures are analysts’ forecasts. Key assumptions include a weighted average cost of capital of 12%, cost of equity 9% and a perpetual growth rate of 1%. All dollar amounts are in millions except share value.

Required: 1, The analyst of ABC used the free cash flows to firm (FCFF) or free cash flow to equity (FCFE) to calculate the free cash flow in this case? And why?

2, Compare the method the analysts of ABC used to calculate free cash flow in this case with the free cash flow method (the one that most suitable for the firm to use in Australia). Is there any difference or not? Explain in detail.

3, What role does the 9% cost of equity play in the free cash flow valuation analysis in this case? How about the role of cost of equity in the abnormal earnings valuation analysis?

4, Explain in detail to someone unfamiliar with present value calculations about how the Present value 2015–2022(i.e., $129.1957) is computed. Please show your detailed calculation with explanations.

5, Explain in detail how the figure $312.2458 for Present value beyond 2022 is computed. Please show your detailed calculation with explanations. 

6, Why does the analyst team subtract an amount for net debt in arriving at Equity value in this case? (Note: The term net debt is defined for spreadsheet purposes as financial liabilities (e.g., loans) minus any financial assets (e.g., money market investments)

7, What share value estimate would the ABC have calculated if they had used an abnormal earnings value approach rather than a discounted cash flow approach and had developed forecasts of abnormal earnings and book values that were consistent with the cash flow forecast in the above worksheet? Why?

8, Sometimes analysts’ research reports contain inadvertent computational errors. What would the estimated value of ABC’s stock have been if the analysts mistakenly used 64 million shares outstanding rather than the correct 46 million share count?

9, If you were the analyst of ABC in June 2014, what would be your investment recommendation advice to the investors of ABC based on your discounted cash flow valuation analysis?
 

Total Revenues: EBITDA Capital expenditures Cash taxes Free cash flow Discount factor: Actual 2014 Present value Present value beyond 2022 Present value 2015-2022 Less net debt Equity value Shares ourstanding Share value 125 5 -0.7 -1.6 2.7 2015 132 6 -1.9 -1.7 2.4 2016 185 8 46 8.463946 -2.2 -2 3.8 2017 220 16 -3.2 -7.8 5 Analyst Forecast 2018 238.5 25 -4 -3 18 2019 275.5 45 -6 -5 34 2020 305.2 60.2 -7 -6.6 46.6 2021 2022 333.5 390.3 90.5 105.3 -9 -8 -10.5 -13.1 71 84.2 0.892857 0.797194 0.71178 0.635518 0.567427 0.506631 0.452349 0.403883 2.142857 3.029337 3.558901 11.43933 19.29251 23.60901 32.11679 34.00697 312.2458 129.1957 441.4415 52.1 389.3415