Question
Mary is considering buying shares in Value Co. She decides that she would buy Value Co shares if the market price of Value Co is
Mary is considering buying shares in Value Co. She decides that she would buy Value Co shares if the market price of Value Co is lower than her estimated value of Value Co, using the discounted cash flow method. For the current year, Value Co has had sales of $2,500,000, an EBIT margin of 25%. For the next five years, Mary expects Value Cos sales to grow by 5% per year, and 1% in perpetuity thereafter. Depreciation is expected to be 15% of sales for the next 7 years, and 8% thereafter. Capital expenditures are expected to be 20% of sales for the next 5 years and 8% thereafter. The net working capital required for operations is 20% of sales. Value Co faces a corporate tax rate of 30% and its after-tax WACC is 9%. Value Co has debt with a market value of $1,500,000, and has 600,000 shares outstanding. Value Cos shares are trading at $9.87 per share. Though most variables are fairly predictable, EBIT margins and capital expenditures show some variability. Mary believes that EBIT margins could be 30% with 20% probability, 25% with 60% probability, and 20% with 20% probability. Capital expenditures for the next five years could be 23% of sales with 30% probability, 20% of sales with 40% probability, and 17% of sales with 30% probability. Capital expenditures after the next five years will be 8% of sales regardless of capital expenditures in the next five years. What is the difference in Value Cos estimated share prices between the best case scenario and worst case scenario, considering the possible variability EBIT margins and capital expenditures? Assume cash flows occur at the end of each year. (Round to the nearest two decimal places)
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