Revenue 11 COGS Gross Profit Operating Expenses EBIT 12 nterest Expense 13 EBT 1
ID: 2653649 • Letter: R
Question
Revenue 11 COGS Gross Profit Operating Expenses EBIT 12 nterest Expense 13 EBT 14 ncome Tax 35% Net Income 15 Earnings per share 16 Dividend per share 17 Expected Return on Equity 18 Estimated Share Price 19 Market value of Equity 20 Market Value of Debt Enterprise Value 21 EBITDA 22 Free Cash Flow Shares outstanding Cost of Debt Beta Expected return on Market Dividend pay-out ratio Dividend growth Risk free Debt Outstanding (Book Value) Common Equity (Book Value) Company's debt trading Change in Working Capital Capital Expenditure Depreciation Expense Firm A 5,000 1,500 (300) 1,200 780 $3,652 600 6% 1.20 8% 40% 3% 4% $600 n/a $(30 $(40 $20 Firm B 5,000 1,500 (300) 1,200 754 $3,626 300 8% 500 8% 40% 3% 4% $500 $300 104 $025 $5045 $20Explanation / Answer
Particular
Working Note
Firm A
Firm B
Revenue
5,000
5,000
COGS (Revenue – Gross Profit)
3500
3500
Gross Profit
1500
1500
Operating Expense
(300)
(300)
EBIT
1200
1200
Interest Expense
0
40
EBT ( Net Income / 0.65)
1200
1160
Income Tax @ 35 %
420
406
Net Income
780
754
Earnings Per Share ( Net Income/ Shares Outstanding)
1.30
2.51
Dividend Per Share
( EPS x Dividend pay-out ratio)
WN-1
0.520
1.004
Expected Return on Equity
WN-2
8.8 %
10 %
Estimates Share Price
WN-3
9.24
14.78
Market Value of Equity
( Market price x shares outstanding)
5544
4434
Market Value of Debt
(1892)
(808)
Enterprise Value
3652
3626
Particulars
Project A
Project B
EBITDA (EBIT + Depreciation)
1220
1220
Free Cash Flow
WN-4
730
744
Working Notes
(WN-1) DPS = Earnings per share x Dividend pay-out ratio
Firm A- 1.30 x 0.40 = 0.520
Firm B- 2.51 x 0.40 = 1.004
(WN-2) Expected return on equity
= Risk Free rate + Beta ( Expected return on market – Risk free rate)
Firm A= 8.8 %
Firm B= 10 %
By simply putting values given in the above formula we will get these numbers)
(WN-3) Share Price = Next expected dividend / ( Cost of equity – Growth )
Firm A = Next Expected dividend = 0.52 x 1.03= 0.536
Price = 0.536 / ( 0.088-0.03) = $ 9.24
Similarly for Project B= $ 14.78
(WN-4)
Free Cash Flow = Operating Cash Flow ( OCF) – Capital Expenditures
Operating Cash Flow = EBIT + Depreciation – Taxes +/- Changes in Working Capital
For Firm A
OCF= 1200+20-420-30
OCF= 770
FCF= 770-40
FCF= 730
For Firm B
OCF= 1200+20-406-25
OCF= 789
FCF= 789-45
FCF= 744
Note- Free Cash Flow – FCF is the cash available to distribute the stakeholders ( debt and Equity holders ) . However some authors take FCF as cash available for equity holders only. In that case Interest should be reduced and tax saving on interest payment will be added.
But here we have taken it for all stake holders ( debt and equity)
Particular
Working Note
Firm A
Firm B
Revenue
5,000
5,000
COGS (Revenue – Gross Profit)
3500
3500
Gross Profit
1500
1500
Operating Expense
(300)
(300)
EBIT
1200
1200
Interest Expense
0
40
EBT ( Net Income / 0.65)
1200
1160
Income Tax @ 35 %
420
406
Net Income
780
754
Earnings Per Share ( Net Income/ Shares Outstanding)
1.30
2.51
Dividend Per Share
( EPS x Dividend pay-out ratio)
WN-1
0.520
1.004
Expected Return on Equity
WN-2
8.8 %
10 %
Estimates Share Price
WN-3
9.24
14.78
Market Value of Equity
( Market price x shares outstanding)
5544
4434
Market Value of Debt
(1892)
(808)
Enterprise Value
3652
3626
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