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3. Stocks and Their Valuation: Corporate Valuation Model The recognition that dividends are dependent on earnings, so a reliable dividend forecast is based on an underlying forecast of the firm's future saies, costs and capital requirements, has led to an alternative stock valuation approach, known as the corporate valuation model. The market value of a firm is equal to the present value of its expected future free cash flows plus the market value of its non-operating assets: Market value of company's non-operating assetn Free cash flows are generally forecasted for 5 to 10 years, after which it is assumed that the final forecasted free cash flow will grow at some long-run constant rate. Once the firm reaches its horizon date, when cash flows begin to grow at a constant rate, the equation to calculate the continuing value of the firm's operations at that date is: Horizonvalue=VCompaty;opertilotsattN=FCFN+1/(WACCgCP) Discount the free cash flows back at the firm's welghted average cost of capital to arrive at the value of the firm todoy. Once the value of the firm's operations are calculated and the value of non-operating assets are added, then the market value of debt and preferred are subtrocted to arrive at the market value of equity. The market value of equity is divided by the number of common shares outstanding to estimate the firm's intrinsic per-share value. We present 2 examples of the corporate valuation model. In the first problem, we assume that the firm is a mature company so its free cilsh flows grow at a constant rate. In the second problem, we assume that the firm has a period of nonconstant growth. Quantitative Problem 1: Assume today is December 31, 2019. Barrington Industries expects that its 2020 after-tax operating incame [EerT(1 - T)] will be $420 million and its 2020 depreciation expense will be $70 million. Barrington's 2020 gross capital expenditures are expected to be $100 milion and the change in its net operating working capital for 2020 will be $20 miltion. The firm's free cash fow is expected to grow at a constant rate of 5.5% annualfy. Assume that its free cash flow occurs at the end of each year. The firm's weighted average cost of capital is 8.8%; the market value of the company's debt is $2.1 billion; and the company has 170 milion shares of common stock outstanding. The firin has no prefictred stock ori ts Quantitative Problem 1: Assume today is December 31, 2019, Barrington Industries expects that its 2020 after-tax operating income. [12611, 1 - 1)] Wili be $420 milion and its 2020 depreciation expense will be $70 mimion, Barrington's 2020 gross capitaf expenditures are expected to be $100 milion and the change in its net opecating working capital for 2020 will be $20 million. The firm's free cash flow is expected to orow at a canstant rate of 5.5% annually. Assume that its free cash flow occurs at the end of each year. The firm's weighted average cost of capital is 8.8%; the market vaiue of the company's debt is $2.1 billion; and the company has 170 million shares of common stock outstanding. The firm has no preferred stock on its the company's debt is $2.1 bilion; and the company has 170 milion shares of common stock outstanding. The form balance sheet and has no plans to use it for future capital budgeling profects: Also; the firm has zero non-operating astets. Using the corperate valuation model, what should be the company's stock price today (December 31,2019 )? Do not round intermediate calculations. Round your answer to the nearest cent. per share Quantitative Problem 2: Hadley Inc. forecasts the year-end free cash flows (in millions) shown below. The weighted average cost of capital is 12%, and the FCFs are expected to continue growing at a 3% rate after Year 5 . The firm has 524 million of market-value debt, but it has no preferred stock or any other outstanding claims. There are 21 million shares outstanding. Also, the firm has zero nonoperating assets. What is the value of the stock price today (Year o)? Round your answer to the nearest cent. Do not round intermediate calculations. 5 per share. According to the valuation models developed in this chapter, the value that an investor assigns to a share of stock is dependent on the length of time the investor plans to hold the stock. The statement above is iselect- 0 . Conclusions Analysts use both the discounted dividend model and the corporate valuation model when valuing mature, dividend-paying firms; and they generally use the corporate model when valuing divisions and firms that do not pay dividends. In principle, we should find the same intrinsic value using eithe model, but differences are often observed. Even if a company is paying steady dividends, much can be leamed from the corporate model; so analysts today use it for all types of yaluations. Th process of projecting future financial statements can reveal a great deal about a company's operations and financing needs. Also, such an analysis provide insights into actions that might be taken to increase the company's value; and for this reason, it is integral to the planning and forecasting rocess: 3. Stocks and Their Valuation: Corporate Valuation Model The recognition that dividends are dependent on earnings, so a reliable dividend forecast is based on an underlying forecast of the firm's future saies, costs and capital requirements, has led to an alternative stock valuation approach, known as the corporate valuation model. The market value of a firm is equal to the present value of its expected future free cash flows plus the market value of its non-operating assets: Market value of company's non-operating assetn Free cash flows are generally forecasted for 5 to 10 years, after which it is assumed that the final forecasted free cash flow will grow at some long-run constant rate. Once the firm reaches its horizon date, when cash flows begin to grow at a constant rate, the equation to calculate the continuing value of the firm's operations at that date is: Horizonvalue=VCompaty;opertilotsattN=FCFN+1/(WACCgCP) Discount the free cash flows back at the firm's welghted average cost of capital to arrive at the value of the firm todoy. Once the value of the firm's operations are calculated and the value of non-operating assets are added, then the market value of debt and preferred are subtrocted to arrive at the market value of equity. The market value of equity is divided by the number of common shares outstanding to estimate the firm's intrinsic per-share value. We present 2 examples of the corporate valuation model. In the first problem, we assume that the firm is a mature company so its free cilsh flows grow at a constant rate. In the second problem, we assume that the firm has a period of nonconstant growth. Quantitative Problem 1: Assume today is December 31, 2019. Barrington Industries expects that its 2020 after-tax operating incame [EerT(1 - T)] will be $420 million and its 2020 depreciation expense will be $70 million. Barrington's 2020 gross capital expenditures are expected to be $100 milion and the change in its net operating working capital for 2020 will be $20 miltion. The firm's free cash fow is expected to grow at a constant rate of 5.5% annualfy. Assume that its free cash flow occurs at the end of each year. The firm's weighted average cost of capital is 8.8%; the market value of the company's debt is $2.1 billion; and the company has 170 milion shares of common stock outstanding. The firin has no prefictred stock ori ts Quantitative Problem 1: Assume today is December 31, 2019, Barrington Industries expects that its 2020 after-tax operating income. [12611, 1 - 1)] Wili be $420 milion and its 2020 depreciation expense will be $70 mimion, Barrington's 2020 gross capitaf expenditures are expected to be $100 milion and the change in its net opecating working capital for 2020 will be $20 million. The firm's free cash flow is expected to orow at a canstant rate of 5.5% annually. Assume that its free cash flow occurs at the end of each year. The firm's weighted average cost of capital is 8.8%; the market vaiue of the company's debt is $2.1 billion; and the company has 170 million shares of common stock outstanding. The firm has no preferred stock on its the company's debt is $2.1 bilion; and the company has 170 milion shares of common stock outstanding. The form balance sheet and has no plans to use it for future capital budgeling profects: Also; the firm has zero non-operating astets. Using the corperate valuation model, what should be the company's stock price today (December 31,2019 )? Do not round intermediate calculations. Round your answer to the nearest cent. per share Quantitative Problem 2: Hadley Inc. forecasts the year-end free cash flows (in millions) shown below. The weighted average cost of capital is 12%, and the FCFs are expected to continue growing at a 3% rate after Year 5 . The firm has 524 million of market-value debt, but it has no preferred stock or any other outstanding claims. There are 21 million shares outstanding. Also, the firm has zero nonoperating assets. What is the value of the stock price today (Year o)? Round your answer to the nearest cent. Do not round intermediate calculations. 5 per share. According to the valuation models developed in this chapter, the value that an investor assigns to a share of stock is dependent on the length of time the investor plans to hold the stock. The statement above is iselect- 0 . Conclusions Analysts use both the discounted dividend model and the corporate valuation model when valuing mature, dividend-paying firms; and they generally use the corporate model when valuing divisions and firms that do not pay dividends. In principle, we should find the same intrinsic value using eithe model, but differences are often observed. Even if a company is paying steady dividends, much can be leamed from the corporate model; so analysts today use it for all types of yaluations. Th process of projecting future financial statements can reveal a great deal about a company's operations and financing needs. Also, such an analysis provide insights into actions that might be taken to increase the company's value; and for this reason, it is integral to the planning and forecasting rocess