CFA Practice Question

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CFA Practice Question

Uwe Henschel is doing a valuation of TechnoSchaft using the following information:

  • 2003 sales per share = $100.
  • Net profit margin = 20%.
  • Net new investment in fixed capital = 30% of sales increase (50% of these investments is financed with debt).
  • Investment in working capital = 20% of sales increase.
  • Beta = 1.3.
  • Risk-free rate = 4%.
  • Equity risk premium = 6%.

He forecasts the following future sales pattern for the company:

The stock of the company is worth ______using the most appropriate type of FCFE model.
A. $261
B. $283
C. $272
Explanation: The company is growing at a constant rate. We use the single stage model in this case.

First we calculate free cash flows to equity for the company:

We then calculate the cost of equity, which will serve as the discount rate in our model: r = rf + beta x equity premium = 0.04 + 1.3 x 0.06 = 0.118, or 11.8%.

The value of the company can be calculated using the single-stage model: Equity value V2003 = FCFE2004 / (r - g) = 19.25 / (0.118 - 0.05) = $283.

User Contributed Comments 6

User Comment
robbe1 Implicit assumption is that working capital is entirely equity financed.
art1997 Cash flow to equity does not depend on cost of working capital, only equity cost
MikeRuz how did they find 0,75 (debt financing)? Can anyone help?
MSRus 1,5*0,5=0,75
philjoe depreciation?
birdperson @MikeRuz -- use this formula FCFE = NI - [(1-DR)*(FCinv - Dep)] - [(1-DR)*(wcinv)] -- note here though that as @robbe1 said -- the WC was not debt financed.... so to answer your question.... 30% of increase (which was 5) = 1.5.... 1.5* DR (50%) = 0.75
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