Use the following information to value Badger Meter Corp. The observed share pri

Question

Use the following information to value Badger Meter Corp. The observed share price on December 1, 2017 was $45.75 per share. The most recent 10-k was dated Nov. 30, 2017.

- WACC (after-tax) is 8% and the estimated cost of equity is 11% for Badger Meter. ?

- All dollar amount items are stated in thousands of dollars. ?

- Shares of Common Stock outstanding (in thousands) is 28,820 ?

- The Terminal Value perpetuity begins in 2021 and dividends are ?assumed to grow at 3.4% annually. Residual income in 2021 is expected to be 5% greater than the amount forecast in 2020. ?

1. Value the shares as at Nov. 30, 2017 using the Discounted Dividends Model

2. Value the shares as at Nov. 30, 2017 using the Discounted Free Cash Flow Model

3. Value the shares as at Nov. 30, 2017 using the Discounted Residual Income Model

Badger Meter (45.75) Total Revenue Net Income Interest Bearing Debt Retained Earnings Total Stockholder Equity Total Cash Flow From Operating Activities Capital Expenditures Dividends Paid Forecast Perp 2017 2018 2019 2020 2021 364,768 377,698393,761 29,678 25,93832,295 86,205 91,98690,51556,300 170,320.00 196,560.00 35,735 35,831 56,185 61,240 (12,332) (19,766) (10,596) (15,400) 10,633 11,261 12,461 14,600

Explanation / Answer

Part 1)

The free cash flow for each year is calculated as below:

Present Value of Free Cash Flow with Discounted Free Cash Flow Model = Free Cash Flow Year 1/(1+WACC)^1 + Free Cash Flow Year 2/(1+WACC)^2 + Free Cash Flow Year 3/(1+WACC)^3 + Terminal Value/(1+WACC)^3 = 23,403/(1+8%)^1 + 16,065/(1+8%)^2 + 45,589/(1+8%)^3 + 45,840/(8% - 3.4%)*1/(1+8%)^3 = $862,703.70

Value of Shares at Nov. 30, 2017 = Present Value of Free Cash Flow with Discounted Free Cash Flow Model/Number of Common Stock Outstanding = 862,703.70/28,820 = $29.93

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Part 2)

The residual income for each year is calculated as below:

Present Value of Residual Income with Discounted Residual Income Model = Residual Income Year 1/(1+WACC)^1 + Residual Income Year 2/(1+WACC)^2 + Residual Income Year 3/(1+WACC)^3 = 8,056/(1+8%)^1 + 4,316/(1+8%)^2 + 10,673/(1+8%)^3 = $19,632.11

Value of Shares at Nov. 30, 2017 = Present Value of Residual Income with Discounted Residual Income Model/Number of Common Stock Outstanding = 19,632.11/28,820 = $.68 per share

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Part 3)

The present value of dividends is calculated as below:

Present Value of Dividends = Dividend Year 1/(1+WACC)^1 + Dividend Year 2/(1+WACC)^2 + Dividend Year 3/(1+WACC)^3 + Terminal Value/(WACC - Growth Rate)*1/(1+WACC)^3 = 10,633/(1+8%)^1 + 11,261/(1+8%)^2 + 12,461/(1+8%)^3 + 14,600/(8% - 3.4%)*1/(1+8%)^3 = $281,347.26

Value of Shares at Nov. 30, 2017 = Present Value of Dividends/Number of Common Stock Outstanding = 281,347.26/28,820 = $9.76

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Assumptions:

1) The growth rate for free cash flows is assumed to be same as growth rate for dividends.

2) The value of debt has been ignored while calculating the market value of equity as it is changing on an yearly basis.

3) The value of operating cash flow and dividends for Year 2021 are assumed to be arrived at after taking the growth rate into consideration.

2018 2019 2020 2021 (Perp) Cash Flow from Operating Activities 35,735 35,831 56,185 61,240 Capital Expenditures 12,332 19,766 10,596 15,400 Free Cash Flow $23,403 $16,065 $45,589 $45,840

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