question archive Below is O’Baby Inc
Below is O’Baby Inc
Subject:FinancePrice:5.87 Bought7
Below is O’Baby Inc.’s financial forecast for the next 3 years. The company is debt-free and has 100 million shares issued and outstanding. The company’s equity beta is 1.2. The risk-free interest rate is 5% and the expected market return is 10%. The company projects an ROE of 10% after 2022 and it plans to maintain a dividend payout ratio of 30%. You are at the beginning of 2020.
(Amounts in million dollars at year end)
| 2020 | 2021 | 2022 | |
| Sales | 6220 | 6657 | 7254 |
| Cost of Sales | 2515 | 2757 | 2953 |
| Depreciation | 1866 | 1998 | 2176 |
| Capital Expenditure | 2417 | 2570 | 2796 |
| Increase in non-cash Net Working Capital | 102 | 126 | 142 |
Required
1) Based on the forecast, what will be the free cash flow to equity (FCFE) over the next 3 years? Assume in your answer that the company continues to be debt-free. Further assume a corporate tax rate of 35%.
2) What is the proper discount rate for FCFEs when computing the intrinsic value of equity?
3) Determine the intrinsic value of the shareholders’ equity at the beginning of 2020? Assume the cost of equity to be 11% and that after 2022 the company’s FCFE will grow at a constant rate.
4) Would you recommend buying O’Baby Co.’s shares if the stock price is $119.54 at the beginning of 2020? Explain your answer briefly.
