For the year ended 31st December 2021, CoVAXX PLC has net operating assets of £120m, a debt of £48m (on which it pays 4% interest before tax), and no financial assets. Its sales were £200m. The following forecasts of value drivers are available to you for the next 3 years:

2022 2023 2024

Growth in sales 5% 3.5% 2.5%

Ratio of closing operating assets-to-sales 0.45 0.5 0.5

Net operating margin before tax 10% 6% 6%

Rate of corporate tax 20% 22% 22%

You estimate the after-tax weighted average cost of capital at 9%, and you do not expect to see any changes in leverage. Assume the book value of debt equals its market value. You understand that the firm’s management team intends to keep future debt fixed at 40% of operating assets and the firm is prepared to raise new equity in order to achieve this if necessary.

Finally, you believe that the year 2024 figures are representative of the company’s long-run situation.

(a) Estimate the net operating profits after tax, the free cash flows of the firm, the

residual income at the firm level, and the dividends to shareholders for the next three years, assuming all free cash flow to equity holders is paid as dividends.

(b) Estimate the enterprise value using both residual income and free cash flow models at the end of 2021 and 2022. Compare and comment on your results.

(c) Estimate the implied cost of equity capital from the WACC and cost of debt for the years 2022-2024 and explain why the cost of equity capital is not constant.

(d) Value the equity of the firm at the end of 2021 and 2022 using both indirect and direct approaches. Compare and comment on your results.

(e) Explain the drawbacks of using the indirect approaches in equity valuation and explain any possible reasons why the indirect and direct approaches may generate different equity values.