Finance Fundamentals-Fall 2021

Self-Test Questions (STQ-6)

Subject: DCF Valuation

1. Ali, a financial analyst at Albaraka Asset Management, has been tasked to assess whether the shares of ABM Steel
would be good addition to the fund's equity portfolio. ABM stock is currently selling at $50 per share. Ali collected
the following financial data on ABM to ascertain the share value based on DCF approach.

• Last year revenues were $500 million. Revenues were expected to grow at a rate of 12% for the next two
years and then taper off to a steady-state growth rate of 3%.
• The firm's operating margin and net profit margin has averaged around 20% and 7%, respectively. Given
the competitive position of ABM, it is likely to maintain these margins in the future. ABM tax rate is 40%.
• ABM had long-term debt of $40 million and interest bearing notes payable of $10 million on its books
which was close to the market value. The firm had IO million shares outstanding. The firm had a stable
capital structure with weighted average cost of capital of 14%.
• The latest values (t = 0) of net property plant and equipment (NPPE) and NWC as per the balance sheet
were, $200 million and $100 million respectively. The firm did not have any surplus (non-operational) cash.
• Going forward, Ali estimated that the firm is likely to improve its NWC turnover to 4X. However, its NPPE
Turnover is likely to remain at 2.5X.
Required:

(a) Estimate the free cash flows to the firm (FCFF) for the next two years and the steady state?
(b) What is your estimate of the terminal value at the end of year 2?
(c) What is your estimate of the total value of equity? Per share value?
(d) Is the stock undervalued or overvalued based on your estimates?

0 1 2 3
Sales 500.0 560.0 627.2 646.0
NWC 100.0 140.0 156.8 161.5
Change in NWC
Fixed Assets 200.0 224.0 250.9 258.4
Change in FA

0 1 2 3
Sales 500.0 560.0 627.2 646.0
EBIT 100.0
Tax@30% 40.0
NOPAT 60.0
Change in NFA
Change in NWC
Total Cash Flows
Terminal Value
FCFF
EV
Less: Debt
Value of Equity
Value per Share
Revenuest=0
500
Operating margin
20%
NWC Turnover
4
Fixed Assets Turnover 3
Forecast Period Growth 12%
SS Growth 3%
Tax 40%
WACC 14%
Debt 50.00
Shares O/S 10

0 1 2 3
Sales 500.0 560.0 627.2 646.0
NWC 100.0 140.0 156.8 161.5
Change in NWC -40.0 -16.8 -4.7
Fixed Assets 200.0 224.0 250.9 258.4
Change in FA -24.0 -26.9 -7.5

0 1 2 3
Sales 500.0 560.0 627.2 646.0
EBIT 100.0 112.0 125.4 129.2
Tax@ 30% 40.0 44.8 50.2 51.7
NOPAT 60.0 67.2 75.3 77.5
Less: Change in FA -24.0 -26.9 -7.5
Change in NWC -40.0 -16.8 -4.7
Total Cash Flows 3.2 31.6 65.3
Terminal Value 593.6
FCFF 3.2 625.1

EV (PV at 12%) 483.83

Less: Debt -50.00 .
Value of Equity 433.83
Value per Sha re $43.38 The stock is overval'ued