Question 1. You have been provided the following information for ExE plc for the year ended 31st December, 2022. It had net operating assets of 150m, debt of 67.5m (on which it pays before tax interest at 5.5%) and no financial assets. Assume the book value of debt equals the market value of debt. Its sales were 200m. The following forecasts of value drivers are also available to you for the next 3 years:

202320242025Growth in sales0.5%1.0%2.0%Closing operating assets(IC)-to-sales ratio0.450.50.5Net operating margin before tax8%9%9%Rate of corporate tax22%20%20%

You estimate the after-tax weighted average cost of capital at 8.5%, and you believe it is robust to any changes in leverage. You understand that the firms management team intends to keep future debt fixed at 45% 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 2025 figures are representative of the companys long-run situation.

REQUIRED (a) Estimate the net operating profits after tax (NOPAT), the free cash flows of the firm (FCFF), the residual income at firm level (RIF), and the dividends to shareholders for the next three years, assuming all free cash flow to equity holders is paid as dividends. (40 marks)

(b) Estimate the current value of equity using the indirect approach from both firm level residual income (RIF) and firm level free cash flow (FCFF) models. (35 marks)

(c) Estimate the implied cost of equity capital from the WACC for years 2023-2025 and explain why the cost of equity is not constant. (15 marks)

(d) Explain the concept of value drivers and describe value drivers in this question. (10 marks)