Eberhart Manufacturing has projected sales of $146 million next year. Costs are

Question

Eberhart Manufacturing has projected sales of $146 million next year. Costs are expected to be $81.5 million, and net investment is expected to be $15.5 million. Each of these values is expected to grow at 17 percent the following year, with the growth rate declining by 2 percent per year until the growth rate reaches 9 percent, where it is expected to remain indefinitely. There are 6 million shares of stock outstanding and investors require a return of 16 percent on the company’s stock. The corporate tax rate is 40 percent.

Explanation / Answer

Calculation of Current Stock Price(By discounted Cash Flow model) Year -------------> 1 2 3 4 5 6 7 Growth Rate 0 17% 15% 13% 11% 9% 9% Sales 146 170.82 196.44 221.98 246.40 268.57 292.75 Expected Cost 81.5 95.36 109.66 123.91 137.54 149.92 163.42 Profit 64.5 75.47 86.78 98.07 108.85 118.65 129.33 Less: Tax 25.8 30.19 34.71 39.23 43.54 47.46 51.73 Profit Net of Tax 38.7 45.28 52.07 58.84 65.31 71.19 77.60 Less: Net Investment 15.5 18.14 20.86 23.57 26.16 28.51 31.08 Free Cash Flows 23.2 27.14 31.22 35.27 39.15 42.68 46.52 Calculation of Present Value of Cash Flows Year Free Cash Flows Present Value Factor @ 16% Present Value 1 23.20 0.862 20.000 2 27.14 0.743 20.172 3 31.22 0.641 19.999 4 35.27 0.552 19.481 5 39.15 0.476 18.642 6 42.68 0.410 17.517 6(For Indefinate Period) 664.57 0.41 272.474 Present Value of Free Cash Flows 388.285 Value of a Common Stock = Total Market Value of Company / Total No. Of Common Stock                                                =388.285/6                                                =64.71 Note 1 : Cash Flow for indefinate period = Cash Flow for Next Year / (Required Rate of Return - Growth Rate)

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