Assume that today is December 31, 2008, and that the following information appli
ID: 2665875 • Letter: A
Question
Assume that today is December 31, 2008, and that the following information applies to Vermail airlines:-After-tax operation income [EBIT(1-T) for 2009 is expected to be $500 million.
-The depreciation expense for 2009 is expected to be $100 million.
-The capital expenditures for 2009 are expected to be $200 million.
-No change is expected in the net working capital.
-The free cash flow is expected to grow at a constant rate of 6% per year.
-The required return on equity is 14%.
-The WACC is 10%.
-The market value of the company's debt is $3 billion.
-200 million shares of stock are outstanding.
Using the corporate value model approach, what should be the company's stock price today?
Explanation / Answer
Net cash flow during 2009 = EBIT(1-T) - cap. exp. = 500 - 200 = 300 m$ (Depreciation is not a cash flow, so not accounted) Debt = 3000 m$ Equity = 200*F m$ (F is face value of stock - not indicated) Total capital = 3000 +200*F m$ Weight of debt, Wd = 3000/(3000+200*F) Weight of Equity, We = 200*F/(3000+200*F) r(E) = cost of equity = 14% WACC, k = 10% g = 6% growth in cash flow. Firm's value at the start of 2009 = cash flow in 2009 /(1+k) + value in 2009/(1+k0 = 300/1.1 + (500/(k-g))/1.1 m$ (cash flow in 2010 will be 500m$, assuming no capital expenditure is there hence after ) = 300/1.1 + 500/((0.10 - 0.06)*1.1) m$ = 11636.36 m$ = Debt + Market value of Equity + Capital investment in 2009 = 3000 + 200* P + 200 m$ ( P is market price of stock) => P = (11636.36 - 3200)/200 ($) => P = 42.18 ($) (ANSWER)