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Sora Industries has 64 million outstanding shares, $129 million in debt, $55 million in cash, and the following projected free cash flow for the next four years: a. Suppose Sora's revenue and free cash flow are expected to grow at a 3.9% rate beyond year four. If Sora's weighted average cost of capital is 14.0%, what is the value of Sora stock based on this information? b. Sora's cost of goods sold was assumed to be 67% of sales. If its cost of goods sold is actually 70% of sales, how would the estimate of the stock's value change? c. Return to the assumptions of part (a) and suppose Sora can maintain its cost of goods sold at 67% of sales. However, the firm reduces its selling, general, and administrative expenses from 20% of sales to 16% of sales. What stock price would you estimate now? (Assume no other expenses, except taxes, are affected.) d. Sora's net working capital needs were estimated to be 18% of sales (their current level in year zero). If Sora can reduce this requirement to 12% of sales starting in year 1, but all other assumptions are as in (a), what stock price do you estimate for Sora? (Hint: This change will have the largest impact on Sora's free cash flow in year 1.) a. Suppose Sora's revenue and free cash flow are expected to grow at a 3.9% rate beyond year four. If Sora's weighted average cost of capital is 14.0%, what is the value of Sora stock based on this information? The stock price for this case is $ 4.63. (Round to the nearest cent.) b. Sora's cost of goods sold was assumed to be 67% of sales. If its cost of goods sold is actually 70% of sales, how would the estimate of the stock's value change? The stock price for this case, when COGS increases, is $ (Round to the nearest cent.) c. Return to the assumptions of part (a) and suppose Sora can maintain its cost of goods sold at 67% of sales. However, the firm reduces its selling, general, and administrative expenses from 20% of sales to 16% of sales. What stock price would you estimate now? (Assume no other expenses, except taxes, are affected.) The stock price for this case, when selling, general, and administrative costs decrease, is $ (Round to the nearest cent.) d. Sora's net working capital needs were estimated to be 18% of sales (their current level in year zero). If Sora can reduce this requirement to 12% of sales starting in year 1, but all other assumptions are as in (a), what stock price do you estimate for Sora? (Hint: This change will have the largest impact on Sora's free cash flow in year 1.) The stock price for this case, when working capital needs are reduced, is $ (Round to the nearest cent.) Worked Solution (Formula Solution) a. You should first estimate the enterprise value, which is the present value of all future free cash flows: 4. FCFA 1 FCF4*(1+GFCF) + Vo= + (1+rwacC)" (1+'wacc) 4 n=1 TWACC - FCF Then, find the price per share as Vo + Casho - Debto Shares Outstandingo First, we estimate the enterprise value, which is the present value of all future free cash flows: ($ million) 1 Vo $33.4 $33.6 $40.1 $43.1 $43.1*(1 + 0.042) x = $478.45 (1 +0.120) (1 + 0.120)2 . (1 + 0.120)3 (1 +0.120)4 (1 +0.120)4 0.120 -0.042 Then, = Po $478.45 million + $41 million - $128 million = $6.12 64 million shares b. Sora's cost of goods sold was assumed to be 67% of sales. If its cost of goods sold is actually 70% of sales, the new projected free cash flow for the next four years is shown below: 0 1 4 433.0 Year Earnings Forecast ($000s) 1 Sales 2 Cost of Goods Sold 3 Gross Profit 4 Selling, General, & Admin. 6 Depreciation 7 EBIT 8 Income Tax at 25% 9 Unlevered Net Income Free Cash Flow ($000s) 10 Plus Depreciation 11 Less: Capital Expenditures 12 Less: Increases in NWC 13 Free Cash Flow 8% 468.0 (327.6) 140.4 (93.6) (7.0) 39.8 (15.9) 29.9 2 10% 516.0 (361.2) 154.8 (103.2) (7.5) 44.1 (176) 33.1 3 6% 547.0 (382.9) 164.1 (109.4) (9.0) 45.7 (18.3) 34.3 5% 574.3 (402.0) 172.3 (114.9) (9.5) 48.0 (19.2) 36.0 7.0 (7.7) (6.3) 22.9 7.5 (10.0) (8.6) 22.0 9.0 (9.9) (5.6) 27.8 9.5 (10.4) (4.9) 30.2 The enterprise value, which is the present value of all future free cash flows, will be as follows: ($ million) $22.9 $22.0 $27.8 $30.2 1 Vo = (1 + 0.120) (1 +0.120)2 (1 +0.120)3 (1 + 0.120)4 (1 + 0.120)4 $30.2 x (1 + 0.042) = $333.35 0.120 -0.042 Then, $333.35 million + $41 million - $128 million Po = 64 million shares = $3.85 C. Return to the assumptions of part (a) and suppose Sora can maintain its cost of goods sold at 67% of sales. However, the firm reduces its selling, general, and administrative expenses from 20% of sales to 16% of sales. The new projected free cash flow for the next four years: 0 1 4 433.0 Year Earnings Forecast ($000s) 1 Sales 2 Cost of Goods Sold 3 Gross Profit 4 Selling, General, & Admin. 6 Depreciation 7 EBIT 8 Income Tax at 25% 9 Unlevered Net Income Free Cash Flow ($000s) 10 Plus: Depreciation 11 Less: Capital Expenditures 12 Less: Increases in NWC 13 Free Cash Flow 8% 468.0 (313.6) 154.4 (74.9) (7.0) 72.6 (18.2) 54.5 2 10% 516.0 (345.7) 170.3 (82.6) (7.5) 80.2 (20.1) 60.2 3 6% 547.0 (366.5) 180.5 (87.5) (9.0) 84.0 (21.0) 63.0 5% 574.3 (384.8) 189.5 (91.9) (9.5) 88.1 (22.0) 66.1 7.0 (7.7) (6.3) 47.5 7.5 (10.0) (8.6) 49.1 9.0 (9.9) (5.6) 56.5 9.5 (10.4) (4.9) 60.3 The enterprise value, which is the present value of all future free cash flows, will be as follows: ($ million) The enterprise value, which is the present value of all future free cash flows, will be as follows: ($ million) 1 $47.5 $49.1 $56.5 $60.3 Vo = (1 + 0.120) (1 +0.120)2 (1 + 0.120)3 (1 +0.120)4 (1+0.120)4 + + + $60.3x(1 + 0.042) - = $672.03 0.120 -0.042 Then, Po = $672.03 million + $41 million - $128 million -= $9.14 64 million shares d. Sora's net working capital needs were estimated to be 18% of sales (their current level in year zero). If Sora can reduce this requirement to 12% of sales starting in year 1, but all other assumptions are as in (a), what stock price do you estimate for Sora? (Hint: This change will have the largest impact on Sora's free cash flow in year 1.) The new projected free cash flow for the next 4 years: 0 433.0 Year Earnings Forecast ($000s) 1 Sales 2. Cost of Goods Sold 3 Gross Profit 4 Selling, General, & Admin. 6 Depreciation 7 EBIT 8 Income Tax at 25% 9 Unlevered Net Income Free Cash Flow ($000s) 10 Plus: Depreciation 11 Less: Capital Expenditures 12 Less: Increases in NWC 13 Free Cash Flow 1 8% 468.0 (313.6) 154.4 (93.6) (7.0) 53.8 (13.5) 2 10% 516.0 (345.7) 170.3 (103.2) (7.5) 59.6 (14.9) 44.7 3 6% 547.0 (366.5) 180.5 (109.4) (9.0) 62.1 (15.5) 46.6 4 5% 574.3 (384.8) 189.5 (114.9) (9.5) 65.2 (16.3) 48.9 40.4 7.0 (7.7) 21.8 61.5 7.5 (10.0) (5.8) 36.4 9.0 (9.9) (3.7) 42.0 9.5 (10.4) (3.3) 44.7 The enterprise value, which is the present value of all future free cash flows, will be as follows: ($ million) $44.7 Vo $61.5 $36.4 $42.0 (1 +0.120) (1 +0.120)2 (1 + 0.120)3 $44.7 x (1 + 0.042) = $521.73 0.120 -0.042 (1 +0.120)4 (1 + 0.120)4 The new projected free cash flow for the next 4 years: 0 4 433.0 Year Earnings Forecast ($000s) Sales Cost of Goods Sold Gross Profit Selling, General, & Admin. 6 Depreciation 7 EBIT 8 Income Tax at 25% 9 Unlevered Net Income Free Cash Flow ($000s) 10 Plus: Depreciation 11 Less: Capital Expenditures 12 Less: Increases in NWC 13 Free Cash Flow 1 8% 468.0 (313.6) 154.4 (93.6) (7.0) 53.8 (13.5) 2 10% 516.0 (345.7) 170.3 (103.2) (7.5) 59.6 (14.9) 44.7 3 6% 547.0 (366.5) 180.5 (109.4) (9.0) 62.1 (15.5) 46.6 5% 574,3 (384.8) 189.5 (114.9) (9.5) 65.2 (16.3) 48.9 40.4 7.0 (7.7) 21.8 61.5 7.5 (10.0) (5.8) 36.4 9.0 (9.9) (3.7) 42.0 9.5 (10.4) (3.3) 44.7 The enterprise value, which is the present value of all future free cash flows, will be as follows: ($ million) Vo $61.5 $36.4 $42.0 $44.7 1 (1 + 0.120) (1 + 0.120) (1 +0.120)3 (1 +0.120)4 (1+0.120)4 + + $44.7*(1 + 0.042) = $521.73 0.120 -0.042 Then, $521.73 million + $41 million - $128 million Po = = $6.79 64 million shares Sora Industries has 64 million outstanding shares, $129 million in debt, $55 million in cash, and the following projected free cash flow for the next four years: a. Suppose Sora's revenue and free cash flow are expected to grow at a 3.9% rate beyond year four. If Sora's weighted average cost of capital is 14.0%, what is the value of Sora stock based on this information? b. Sora's cost of goods sold was assumed to be 67% of sales. If its cost of goods sold is actually 70% of sales, how would the estimate of the stock's value change? c. Return to the assumptions of part (a) and suppose Sora can maintain its cost of goods sold at 67% of sales. However, the firm reduces its selling, general, and administrative expenses from 20% of sales to 16% of sales. What stock price would you estimate now? (Assume no other expenses, except taxes, are affected.) d. Sora's net working capital needs were estimated to be 18% of sales (their current level in year zero). If Sora can reduce this requirement to 12% of sales starting in year 1, but all other assumptions are as in (a), what stock price do you estimate for Sora? (Hint: This change will have the largest impact on Sora's free cash flow in year 1.) a. Suppose Sora's revenue and free cash flow are expected to grow at a 3.9% rate beyond year four. If Sora's weighted average cost of capital is 14.0%, what is the value of Sora stock based on this information? The stock price for this case is $ 4.63. (Round to the nearest cent.) b. Sora's cost of goods sold was assumed to be 67% of sales. If its cost of goods sold is actually 70% of sales, how would the estimate of the stock's value change? The stock price for this case, when COGS increases, is $ (Round to the nearest cent.) c. Return to the assumptions of part (a) and suppose Sora can maintain its cost of goods sold at 67% of sales. However, the firm reduces its selling, general, and administrative expenses from 20% of sales to 16% of sales. What stock price would you estimate now? (Assume no other expenses, except taxes, are affected.) The stock price for this case, when selling, general, and administrative costs decrease, is $ (Round to the nearest cent.) d. Sora's net working capital needs were estimated to be 18% of sales (their current level in year zero). If Sora can reduce this requirement to 12% of sales starting in year 1, but all other assumptions are as in (a), what stock price do you estimate for Sora? (Hint: This change will have the largest impact on Sora's free cash flow in year 1.) The stock price for this case, when working capital needs are reduced, is $ (Round to the nearest cent.) Worked Solution (Formula Solution) a. You should first estimate the enterprise value, which is the present value of all future free cash flows: 4. FCFA 1 FCF4*(1+GFCF) + Vo= + (1+rwacC)" (1+'wacc) 4 n=1 TWACC - FCF Then, find the price per share as Vo + Casho - Debto Shares Outstandingo First, we estimate the enterprise value, which is the present value of all future free cash flows: ($ million) 1 Vo $33.4 $33.6 $40.1 $43.1 $43.1*(1 + 0.042) x = $478.45 (1 +0.120) (1 + 0.120)2 . (1 + 0.120)3 (1 +0.120)4 (1 +0.120)4 0.120 -0.042 Then, = Po $478.45 million + $41 million - $128 million = $6.12 64 million shares b. Sora's cost of goods sold was assumed to be 67% of sales. If its cost of goods sold is actually 70% of sales, the new projected free cash flow for the next four years is shown below: 0 1 4 433.0 Year Earnings Forecast ($000s) 1 Sales 2 Cost of Goods Sold 3 Gross Profit 4 Selling, General, & Admin. 6 Depreciation 7 EBIT 8 Income Tax at 25% 9 Unlevered Net Income Free Cash Flow ($000s) 10 Plus Depreciation 11 Less: Capital Expenditures 12 Less: Increases in NWC 13 Free Cash Flow 8% 468.0 (327.6) 140.4 (93.6) (7.0) 39.8 (15.9) 29.9 2 10% 516.0 (361.2) 154.8 (103.2) (7.5) 44.1 (176) 33.1 3 6% 547.0 (382.9) 164.1 (109.4) (9.0) 45.7 (18.3) 34.3 5% 574.3 (402.0) 172.3 (114.9) (9.5) 48.0 (19.2) 36.0 7.0 (7.7) (6.3) 22.9 7.5 (10.0) (8.6) 22.0 9.0 (9.9) (5.6) 27.8 9.5 (10.4) (4.9) 30.2 The enterprise value, which is the present value of all future free cash flows, will be as follows: ($ million) $22.9 $22.0 $27.8 $30.2 1 Vo = (1 + 0.120) (1 +0.120)2 (1 +0.120)3 (1 + 0.120)4 (1 + 0.120)4 $30.2 x (1 + 0.042) = $333.35 0.120 -0.042 Then, $333.35 million + $41 million - $128 million Po = 64 million shares = $3.85 C. Return to the assumptions of part (a) and suppose Sora can maintain its cost of goods sold at 67% of sales. However, the firm reduces its selling, general, and administrative expenses from 20% of sales to 16% of sales. The new projected free cash flow for the next four years: 0 1 4 433.0 Year Earnings Forecast ($000s) 1 Sales 2 Cost of Goods Sold 3 Gross Profit 4 Selling, General, & Admin. 6 Depreciation 7 EBIT 8 Income Tax at 25% 9 Unlevered Net Income Free Cash Flow ($000s) 10 Plus: Depreciation 11 Less: Capital Expenditures 12 Less: Increases in NWC 13 Free Cash Flow 8% 468.0 (313.6) 154.4 (74.9) (7.0) 72.6 (18.2) 54.5 2 10% 516.0 (345.7) 170.3 (82.6) (7.5) 80.2 (20.1) 60.2 3 6% 547.0 (366.5) 180.5 (87.5) (9.0) 84.0 (21.0) 63.0 5% 574.3 (384.8) 189.5 (91.9) (9.5) 88.1 (22.0) 66.1 7.0 (7.7) (6.3) 47.5 7.5 (10.0) (8.6) 49.1 9.0 (9.9) (5.6) 56.5 9.5 (10.4) (4.9) 60.3 The enterprise value, which is the present value of all future free cash flows, will be as follows: ($ million) The enterprise value, which is the present value of all future free cash flows, will be as follows: ($ million) 1 $47.5 $49.1 $56.5 $60.3 Vo = (1 + 0.120) (1 +0.120)2 (1 + 0.120)3 (1 +0.120)4 (1+0.120)4 + + + $60.3x(1 + 0.042) - = $672.03 0.120 -0.042 Then, Po = $672.03 million + $41 million - $128 million -= $9.14 64 million shares d. Sora's net working capital needs were estimated to be 18% of sales (their current level in year zero). If Sora can reduce this requirement to 12% of sales starting in year 1, but all other assumptions are as in (a), what stock price do you estimate for Sora? (Hint: This change will have the largest impact on Sora's free cash flow in year 1.) The new projected free cash flow for the next 4 years: 0 433.0 Year Earnings Forecast ($000s) 1 Sales 2. Cost of Goods Sold 3 Gross Profit 4 Selling, General, & Admin. 6 Depreciation 7 EBIT 8 Income Tax at 25% 9 Unlevered Net Income Free Cash Flow ($000s) 10 Plus: Depreciation 11 Less: Capital Expenditures 12 Less: Increases in NWC 13 Free Cash Flow 1 8% 468.0 (313.6) 154.4 (93.6) (7.0) 53.8 (13.5) 2 10% 516.0 (345.7) 170.3 (103.2) (7.5) 59.6 (14.9) 44.7 3 6% 547.0 (366.5) 180.5 (109.4) (9.0) 62.1 (15.5) 46.6 4 5% 574.3 (384.8) 189.5 (114.9) (9.5) 65.2 (16.3) 48.9 40.4 7.0 (7.7) 21.8 61.5 7.5 (10.0) (5.8) 36.4 9.0 (9.9) (3.7) 42.0 9.5 (10.4) (3.3) 44.7 The enterprise value, which is the present value of all future free cash flows, will be as follows: ($ million) $44.7 Vo $61.5 $36.4 $42.0 (1 +0.120) (1 +0.120)2 (1 + 0.120)3 $44.7 x (1 + 0.042) = $521.73 0.120 -0.042 (1 +0.120)4 (1 + 0.120)4 The new projected free cash flow for the next 4 years: 0 4 433.0 Year Earnings Forecast ($000s) Sales Cost of Goods Sold Gross Profit Selling, General, & Admin. 6 Depreciation 7 EBIT 8 Income Tax at 25% 9 Unlevered Net Income Free Cash Flow ($000s) 10 Plus: Depreciation 11 Less: Capital Expenditures 12 Less: Increases in NWC 13 Free Cash Flow 1 8% 468.0 (313.6) 154.4 (93.6) (7.0) 53.8 (13.5) 2 10% 516.0 (345.7) 170.3 (103.2) (7.5) 59.6 (14.9) 44.7 3 6% 547.0 (366.5) 180.5 (109.4) (9.0) 62.1 (15.5) 46.6 5% 574,3 (384.8) 189.5 (114.9) (9.5) 65.2 (16.3) 48.9 40.4 7.0 (7.7) 21.8 61.5 7.5 (10.0) (5.8) 36.4 9.0 (9.9) (3.7) 42.0 9.5 (10.4) (3.3) 44.7 The enterprise value, which is the present value of all future free cash flows, will be as follows: ($ million) Vo $61.5 $36.4 $42.0 $44.7 1 (1 + 0.120) (1 + 0.120) (1 +0.120)3 (1 +0.120)4 (1+0.120)4 + + $44.7*(1 + 0.042) = $521.73 0.120 -0.042 Then, $521.73 million + $41 million - $128 million Po = = $6.79 64 million shares