Assume that today is December 31, 2016, and that the following information appli
ID: 2781014 • Letter: A
Question
Assume that today is December 31, 2016, and that the following information applies to Abner Airlines:
- After-tax operating income [EBIT(1 - T)] for 2017 is expected to be $400 million.
- The depreciation expense for 2017 is expected to be $180 million.
- The capital expenditures for 2017 are expected to be $200 million.
- No change is expected in net operating working capital.
- The free cash flow is expected to grow at a constant rate of 3% per year.
- The required return on equity is 14%.
- The WACC is 10%.
- The market value of the company's debt is $5 billion.
- 90 million shares of stock are outstanding.
Using the corporate valuation model approach, what should be the company's stock price today? Round your answer to the nearest cent. Write out your answer completely. For example, 0.00013 million should be entered as 130.
Explanation / Answer
Under the corporate valuation model approach we first need to calculate the free cash flow in order to find the Price of the stock as of 31st December 2016;
EBIT (1-T) + Depreciation & Amortization – Capex – Change in Net working capital
EBIT (1-T) =$400million
Depreciation & Amortization = $180million
Change in Working Capital = Nil
Capex = $200 million
Or, Free cash flow to the firm = $400 + $180 - $200 = $380 million
Again, since the valuation of the firm has been considered so we need to considered the WACC which is 10%
Growth rate of the company is 3% (constant growth)
Value of the firm =Free Cash Flow * (1 + Growth Rate)/ (WACC – Growth Rate)
Or, value of the firm = $380*1.03/ (0.10- 0.03) = $5591.43 million
Company has 90 million shares, so Price of the stock as of 31st December 2016 = $5591.43/90 = $62.13