Equity Valuation Models (Free Cash Flow to Equity Model)

1. Ajay Sharma is an analyst with Reliable Mutual Fund and is trying to value the stock of ABC Forge Ltd using the FCFE model. He believes that ABC Firges FCFE will grow at 27% for 2 years and 13% thereafter. Capital expenditure, depreciation and working capital are all expected to grow proportionately with FCFE. From the following data calculate: a. The amount of FCFE per share for the year 2008 b. The current value of a share of ABC Forge Ltd based on the 2-stage FCFE model Income Statement (Rs.Millions) Revenue Depreciation Other operating costs Income before tax Tax Net income Dividends Earnings per share Dividends Per Share Outstanding shares (millions) Balance Sheet (Rs.Millions) Current assets Fixed Assets Total Assets Current liabilities Long-term Debt Total Liabilities Shareholders' Equity Total Liabilities and Equity Capital Expenditure Selected Financial Information 2007 474 20 368 86 26 60 18 0.714 0.214 84 2008 598 23 460 115 35 80 24 0.952 0.286 84

2007 201 474 675 57 0 57 618 675 34

2008 326 489 815 141 0 141 674 815 38

Required rate of return on Equity Growth rate of Industry Industry P/E ratio

14% 13% 26

2. Savita is valuing the stock of Stronglite Metals using the FCFE model. Based on the following data calculate: a. Suatainable growth rate of Stronglite Metals based on 2008 beginning of the eyar balance sheet values b. Free Cash Flow to equity for the year 2008 c. If the normalized earnings per share of the Company is estimated at Rs.1.71, the earnings growth rate for the Company is estimated at 11% and the current share price is Rs.25, are the Companys shares overvalued or undervalued on a P/E-to-growth (PEG) basis using the normalized EPS compared to the industry as a whole? (Rs.Millio ns) 2008 13.00 30.00 209.06 252.06 474.47 (154.17) 320.30 572.36 25.05 25.05 240.00 265.05 160.00 147.31 307.31 572.36

Balance Sheet Cash Accounts receivable Inventory Current Assets Gross Fixed Assets Accumulated Deprn Net Fixed Assets Total Assets Accounts Payable Current Liabilities Long-term Debt Total Liabilities Share Capital Retained earnings Total Shareholders' equity Total Liabilities and Shareholders'Equity Income Statement (Rs.Million) Revenue Total Operating expenses

2007 5.87 27.00 189.06 221.93 409.47 (90.00) 319.47 541.40 26.05 26.05 245.00 271.05 150.00 120.35 270.35 541.40 Y.e.200 8 300.80 -173.74

Operating profit Gain on sale of fixed assets EBITDA Depreciation & Amortization EBIT Interest Tax Net Income Notes to Accounts for 2008

127.06 4.00 131.06 -71.17 59.89 -16.80 -12.93 30.16

Note 1: The Company had Rs.75 million in capital expenditure during the year Note 2: Machinery with original cost of Rs.10 million and book value of Rs.3 million was sold for rs.7 million. Machinery sales is an unusual item for the Company Note 3: Decrease in long-term debt represents an unscheduled principal repayment, there was no new borrowing for the year Note 4: On January 1, 2008, the company received cash by issuing 400,000 shares at a price of rs.25 per share Note 5: A revaluation of land during the year increased the estimated market value of land held for investment by Rs.2 million which was not recognized in the 2008 net profit. Company data for 2008 Dividends paid (Rs.million) Outstanding number of shares Dividend per share Earnings per share Beta Industry & Market data Dec 31, 2008 Risk-free rate of return Expected return on market index Median Industry PE Expected Industry earnings growth rate

3.2 1600000 0 0.2 1.89 1.8

4.00% 9.00% 19.90 12.00%