Self-Test Problem

Corporate Valuation

Watkins Inc. has never paid a dividend, and when it might begin paying dividends is unknown.

 Its current free cash flow is $100,000,

 and this FCF is expected to grow at a constant 7% rate.
 The weighted average cost of capital is WACC 11%.
 Watkins currently holds $325,000 of nonoperating marketable securities.
 Its long-term debt is $1,000,000, but it has never issued preferred stock.
 Watkins has 50,000 shares of stock outstanding.

a. Calculate Watkins’ value of operations.

b. Calculate the company’s total value.

c. Calculate the value of its common equity.

d. Calculate the per share stock price.

15-6)

Value of Operations

Brooks Enterprises has never paid a dividend. Free cash flow is projected to be
$80,000 and $100,000 for the next 2 years, respectively, and after the second year it
is expected to grow at a constant rate of 8%. The company’s weighted average cost
of capital is WACC = 12%.
a. What is the terminal, or horizon, value of operations? (Hint: Find the value of
all free cash flows beyond Year 2 discounted back to Year 2.)
b. Calculate the value of Brooks’ operations.

(15-6) a. HV2 = $2,700,000.

b. $2,303,571.43.
(15-10)

Corporate Valuation

The financial statements of Lioi Steel Fabricators are shown below, with the actual
results for 2007 and the projections for 2008. Free cash flow is expected to grow at
a 6% rate after 2008. The weighted average cost of capital is 11%.
a. If operating capital as of 12/31/2007 is $502.2 million, what is the free cash
flow for 12/31/2008?
b. What is the horizon value as of 12/31/2008?
c. What is the value of operations as of 12/31/2007?
d. What is the total value of the company as of 12/31/2007?
e. What is the price per share for 12/31/2007?
a. NOPAT2008 = $108.6(1-0.4) = $65.16
NOWC2008 = ($5.6 + $56.2 + $112.4) – ($11.2 + $28.1) = $134.9 million.
Capital2008 = $134.9 + $397.5 = $532.4 million.
FCF2008 = NOPAT – Investment in Capital = $65.16 – ($532.4 - $502.2)
= $65.16 - $30.2 = $34.96 million.
b. HV2008 = [$34.96(1.06)]/(0.11-0.06) = $741.152 million.
c. VOp at 12/31/2007 = [$34.96 + $741.152]/(1+0.11) = $699.20 million.
d. Total corporate value = $699.20 + $49.9 = $749.10 million.
e. Value of equity = $749.10 – ($69.9 + $140.8) - $35.0 = $503.4 million.
Price per share = $503.4 / 10 = $50.34.