FCFF Calculation and Valuation

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Part A

2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Sales Growth 102.22% 19.50% 6.50% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00%
Operating Margin (EBIT/Sales) 49.39% 50.93% 50.91% 49.92% 48.97% 47.93% 46.81% 37.95% 35.50%
Depreciation 3,424 3,508 3,533 3,558 3,583 3,608 3,633 3,658 3,683
Capital Expenditure 1675 500 500 500 500 500 500 500 500
Investment in NWC (% of additional sales amount) 20% 10% 10% 10% 10% 10% 5% 5% 5%
Year 0 1 2 3 4 5 6 7 8 9
Sales      14,833.34 29,995.99    35,845.20    38,175.14 40,083.90 42,088.09 44,192.50 46,402.12 48,722.23    51,158.34
EBIT 14,815.02    18,255.96    19,434.96 20,009.88 20,610.54 21,181.46 21,720.83 18,490.09    18,161.21
After-tax Operating Income    9,629.76    11,866.38    12,632.73 13,006.42 13,396.85 13,767.95 14,118.54 12,018.56    11,804.79
Add: Depreciation    3,424.00      3,508.00      3,533.00    3,558.00    3,583.00    3,608.00    3,633.00    3,658.00      3,683.00
Less: Investment in Net Working Capital    3,032.53        584.92        232.99      190.88      200.42      210.44      110.48      116.01        121.81
Less: Investment in Fixed Assets    1,675.00        500.00        500.00      500.00      500.00      500.00      500.00      500.00        500.00
FCFF    8,346.23    14,289.45    15,432.73 15,873.55 16,279.43 16,665.51 17,141.06 15,060.55    14,865.98
126,703.58
Discounted Value of FCFF $7,252.24 $10,788.95 $10,124.84 $9,049.01 $8,063.96 $7,173.14 $6,410.77 $4,894.35 $4,197.88
FCFF Valuation
PV of FCFF (year 1-9) $67,955.13
PV of terminal value $35,778.72
Value of firm’s operating assets $103,733.86
Add: cash 3839.00
Less: Debt      37,490.00
Value of Common Equity 70082.86
Fair Price per share            33.37
Calculation of WACC
MV Weight A-T Cost
Equity      48,132.00 0.58278948 20.300%
Debt      34,457.00 0.41721052 7.800%
Total Market Value of Long-term Capital      82,589.00          1.00 15.085%
Number of Shares (millions) 2,100
Beta (historical) 1.15
Market Price (December 31, 2011) 22.92
Interest rate on LT debt 12%
Tax rate 35%
Terminal growth rate 3%
Risk-free rate 11.50%
Market Premium 8%
Adjusted Beta 1.10
Cash 3839.00
Debt 37490
Sales 14,833.34

 

Part B I

2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Sales Growth 102.22% 19.50% 6.50% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00%
Operating Margin (EBIT/Sales) 49.39% 50.93% 50.91% 49.92% 48.97% 47.93% 46.81% 37.95% 35.50%
Depreciation 3,424 3,508 3,533 3,558 3,583 3,608 3,633 3,658 3,683
Capital Expenditure 1675 500 500 500 500 500 500 500 500
Investment in NWC (% of additional sales amount) 20% 10% 10% 10% 10% 10% 5% 5% 5%
Year 0 1 2 3 4 5 6 7 8 9
Sales      14,833.34        29,995.99      35,845.20      38,175.14        40,083.90        42,088.09        44,192.50        46,402.12      48,722.23                  51,158.34
EBIT      9,150.62        14,815.02      18,255.96      19,434.96        20,009.88        20,610.54        21,181.46        21,720.83      18,490.09                  18,161.21
After-tax Operating Income      5,947.90          9,629.76      11,866.38      12,632.73        13,006.42        13,396.85        13,767.95        14,118.54      12,018.56                  11,804.79
Add: Depreciation          746.38          3,424.00        3,508.00        3,533.00          3,558.00          3,583.00        3,608.00          3,633.00        3,658.00                    3,683.00
Less: Investment in Net Working Capital          3,032.53          584.92          232.99            190.88            200.42            210.44            110.48          116.01                      121.81
Less: Investment in Fixed Assets          1,675.00          500.00          500.00            500.00            500.00            500.00            500.00          500.00                      500.00
FCFF          8,346.23      14,289.45      15,432.73        15,873.55        16,279.43        16,665.51        17,141.06      15,060.55                  14,865.98
                 98,548.96    106,601.22    115,884.25    126,703.58    139,475.01    154,779.22    173,452.60    196,745.32    226,613.38    266,298.61    321,592.98
Discounted Value of FCFF $7,252.24 $10,788.95 $10,124.84 $9,049.01 $8,063.96 $7,173.14 $6,410.77 $4,894.35 $4,197.88
FCFF Valuation
PV of FCFF (year 1-9) $67,955.13
PV of terminal value $27,828.39 $30,102.19 $32,723.55 $35,778.72 $39,385.14 $43,706.76 $48,979.77 $55,557.20 $63,991.39 $75,197.75 $90,811.85
Value of firm’s operating assets $95,783.52 $98,057.33 $100,678.68 $103,733.86 $107,340.27 $111,661.89 $116,934.91 $123,512.34 $131,946.52 $143,152.89 $158,766.98
Add: cash      3,839.00          3,839.00        3,839.00        3,839.00          3,839.00          3,839.00        3,839.00          3,839.00        3,839.00                    3,839.00      3,839.00
Less: Debt      37,490.00        37,490.00      37,490.00      37,490.00        37,490.00        37,490.00        37,490.00        37,490.00      37,490.00                  37,490.00      37,490.00
Value of Common Equity 62132.52 64406.33 67027.68 70082.86 73689.27 78010.89 83283.91 89861.34 98295.52 109501.89 125115.98
Fair Price per share            29.59              30.67            31.92            33.37              35.09              37.15            39.66              42.79            46.81                        52.14            59.58
Calculation of WACC
MV Weight A-T Cost
Equity      48,132.00 0.582789476 20.300%
Debt      34,457.00 0.417210524 7.800%
Total Market Value of Long-term Capital      82,589.00                1.00 15.085%
Number of Shares (millions) 2,100
Beta (historical) 1.15
Market Price (December 31, 2011) 22.92
Interest rate on LT debt 12%
Tax rate 35%
Terminal growth rate 0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%
Risk-free rate 11.50%
Market Premium 8%
Adjusted Beta 1.10
Cash 3839.00
Debt 37490
Sales 14,833.34

 

Part B II

2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Sales Growth 102.22% 19.50% 6.50% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00%
Operating Margin (EBIT/Sales) 49.39% 50.93% 50.91% 49.92% 48.97% 47.93% 46.81% 37.95% 35.50%
Depreciation 3,424 3,508 3,533 3,558 3,583 3,608 3,633 3,658 3,683
Capital Expenditure 1675 500 500 500 500 500 500 500 500
Investment in NWC (% of additional sales amount) 20% 10% 10% 10% 10% 10% 5% 5% 5%
Year 0 1 2 3 4 5 6 7 8 9
Sales        14,833.34    29,995.99    35,845.20    38,175.14    40,083.90    42,088.09    44,192.50    46,402.12    48,722.23    51,158.34
EBIT    14,815.02    18,255.96    19,434.96    20,009.88    20,610.54    21,181.46    21,720.83    18,490.09    18,161.21
After-tax Operating Income      9,629.76    11,866.38    12,632.73    13,006.42    13,396.85    13,767.95    14,118.54    12,018.56    11,804.79
Add: Depreciation 3,424 3,508 3,533 3,558 3,583 3,608 3,633 3,658 3,683
Less: Investment in Net Working Capital      3,032.53        584.92        232.99        190.88        200.42        210.44        110.48        116.01        121.81
Less: Investment in Fixed Assets 1675 500 500 500 500 500 500 500 500
FCFF      8,346.23    14,289.45    15,432.73    15,873.55    16,279.43    16,665.51    17,141.06    15,060.55    14,865.98
126,703.58 184,554.02 172,441.19 161,820.44 152,432.06 144,073.32 136,583.64 129,834.19 123,720.39 118,156.48 113,071.48 108,406.09
Discounted Value of FCFF $7,252.24 $10,788.95 $10,124.84 $9,049.01 $8,063.96 $7,173.14 $6,410.77 $4,894.35 $4,197.88
FCFF Valuation
PV of FCFF (year 1-9) $67,955.13
PV of terminal value $35,778.72 $70,433.88 $62,789.27 $56,230.27 $50,560.40 $45,626.69 $41,308.37 $37,508.90 $34,150.18 $31,168.48 $28,511.24 $26,134.82
Value of firm’s operating assets $103,733.86 $138,389.01 $130,744.40 $124,185.40 $118,515.53 $113,581.82 $109,263.51 $105,464.03 $102,105.32 $99,123.61 $96,466.38 $94,089.95
Add: cash          3,839.00      3,839.00      3,839.00      3,839.00      3,839.00      3,839.00      3,839.00      3,839.00      3,839.00      3,839.00      3,839.00    3,839.00
Less: Debt        37,490.00    37,490.00    37,490.00    37,490.00    37,490.00    37,490.00    37,490.00    37,490.00    37,490.00    37,490.00    37,490.00    37,490.00
Value of Common Equity 70082.86 104738.01 97093.40 90534.40 84864.53 79930.82 75612.51 71813.03 68454.32 65472.61 62815.38 60438.95
Fair Price per share              33.37          49.88          46.23          43.11          40.41          38.06          36.01          34.20          32.60          31.18          29.91        28.78
Calculation of WACC
MV Weight A-T Cost 5 6 7 8 9 10 11 12 13 14 15
Equity        48,132.00 0.582789476 20.300% 13.800% 14.800% 15.800% 16.800% 17.800% 18.800% 19.800% 20.800% 21.800% 22.800% 23.800%
Debt        34,457.00 0.417210524 7.800%
Total Market Value of Long-term Capital        82,589.00          1.00 15.085% 11.297% 11.880% 12.462% 13.045% 13.628% 14.211% 14.793% 15.376% 15.959% 16.542% 17.125%
Number of Shares (millions) 2,100
Beta (historical) 1.15
Market Price (December 31, 2011) 22.92
Interest rate on LT debt 12%
Tax rate 35%
Terminal growth rate 3%
Risk-free rate 11.50% 5.00% 6.00% 7.00% 8.00% 9.00% 10.00% 11.00% 12.00% 13.00% 14.00% 15.00%
Market Premium 8% 8% 8% 8% 8% 8% 8% 8% 8% 8% 8% 8%
Adjusted Beta 1.10 1.10 1.10 1.10 1.10 1.10 1.10 1.10 1.10 1.10 1.10 1.10
Cash 3839.00
Debt 37490
Sales 14,833.34

 

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Fatima Fertilizers Company Limited: Sensitivity Analysis in Stock Valuation

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This was a spreadsheet assignment given to me for the course Financial Management, which I took with Ms. Sana Fatima in Spring 2014. You can refer to the case, its solution at the end and answers to some critical questions in this blog. If you can think of more reasons for the Critical thinking answers, please do share them in the comments.

Spreadsheet Assignment 1

Fatima Fertilizers Company Limited

Sensitivity Analysis in Stock Valuation

 

Fatima Fertilizer Company Limited, a fully integrated fertilizer complex, was incorporated on 24th December, 2003 as a joint venture between two major business groups of Pakistan: Fatima Group and Arif Habib Group. The Company is listed at all stock exchanges of Pakistan, through a successful initial public offering (IPO) in February 2010 to fund the requirement of the project at the time of the listing.

 

Fatima Fertilizer currently maintains highest profit margins among its peers due to its diversified product portfolio (urea, CAN and NP) and consistent gas from the dedicated Mari gas field. The companies on the Sui gas network face large unpredictable swings in gas supply leading to detrimental effects on their productivity. These advantages of Fatima will translate into a high sales growth for the next 2-3 years and high operating margins (Exhibit 2).

Arif Habib group has had a history of paying strong dividends in all of their subsidiaries. The management of Fatima will try to reach a payout ratio of 75% as soon as possible; however, it will be difficult to achieve that in near future due to the accelerated debt repayments which they have planning. Fatima plans to achieve a debt free status by 2017 and thus, most of the cash generated from operations will be used to pay off debts in the next five years; hampering their ability to pay high dividends. Once the debt-free status is achieved in CY17, Fatima fertilizer will shift to the desired payout ratio of 75%.

 

Based on the assumption that in the long run fertilizer demand in Pakistan will be limited by the availability of cultivable land, the terminal growth rate in FCFF is pegged to the GDP growth rate of 3%.

 

Given the unavailability of gas, Fatima is not expected to expand its production capacity; however, the company will incur maintenance capital expenditure of about PKR500 mn starting from CY14 onwards. The balance sheet and income statement for the year just ended are given in exhibit 1. Market value of company’s long-term debt is same as the book value. Projected financials for the company are given in exhibits 2. The market premium is estimated to be 8% and risk-free rate is 11.5%. Historical beta for Fatima’s stock is 1.15×.

 

  1. Using the given information, compute the fair price per share of Fatima stock on Dec 31, 2011. Use FCFF valuation Model.
  2. Show how the fair price will change if:

                     i.        The terminal growth rate changes (vary the TG rate from 0% to 10% with intervals of 1%).

                   ii.        The risk-free rate changes (vary the RF rate from 5% to 15% with intervals of 1%).

Exhibit 1: Balance Sheet and Income Statement

 

     (Millions PKR)

Year-ended December 2011
Net Sales 14,833.343
EBITDA    8,404.245
Depreciation and Amortization        746.378
EBIT    9,150.623
Financial charges    3,063.055
Pre-tax Profit    6,087.568
As of December 2011
Cash 3,839
Trade Debt 196
Inventory 1,215
Other current assets 2,876
Total Current Assets 8,126
Net Fixed Assets 68,221
Total Assets 76,347
Creditors & accruals 7,725
ST Borrowings 0
Current Portion: LT Debt 3,033
Total Current Liabilities 10,758
LT Debt 34,457
Deferred Liabilities 3,077
Total Liabilities 48,292
Paid-up 24,000
Share premium 790
Un-appropriated Profit 3,265
Total Equity 28,055
Additional Data:
Tax rate (%) 35
Interest rate on LT Debt (%) 12
Market Price per share (PKR) 22.92
Number of common shares (million) 2,100

 

Exhibit 2: Forecasted Financials

2012 2013 2014 2015 2016
Sales Growth 102.22% 19.50% 6.50% 5.00% 5.00%
Operating Margin (EBIT/Sales) 49.39% 50.93% 50.91% 49.92% 48.97%
Depreciation    3,424 3,508 3,533 3,558 3,583
Capital Expenditure 1675 500 500 500 500
Investment in NWC (% of additional sales amount) 20% 10% 10% 10% 10%

 

 

2017 2018 2019 2020
Sales Growth 5.00% 5.00% 5.00% 5.00%
Operating Margin (EBIT/Sales) 47.93% 46.81% 37.95% 35.5%
Depreciation 3,608    3,633    3,658 3,683
Capital Expenditure 500 500 500 500
Investment in NWC (% of additional sales amount) 10% 5% 5% 5%

 

Answers to Critical Thinking Questions:

  1. Why is the DDM model not appropriate for valuing the stock of Fatima?

 

The following reasons serve why DDM is inappropriate for Fatima:

  1. Because company is not a dividend paying firm, hence DDM model is not applicable here.
  2. The payout ratio is constant at 75%, hence there is no link between the profitability of the company and the dividend payout ratio, hence DDM is inappropriate to apply here.
  3. Also, since the company is observing a group holding structure which gives it a control perspective hence it serves as another reason why DDM is inappropriate here.

 

  1. Why is the FCFE model not appropriate for valuing the stock of Fatima?

 

  • Since Fatima plans to achieve a debt-free status by 2017, thus changing its capital structure hence the FCFE is not appropriate.
  • The future cash-flows tend to be negative due to the future high repayments, thus making FCFE negative, not reflecting the company’s actual state.

 

  1. What will happen to the beta value of Fatima stock once it achieves the debt-free status in CY17 as planned?

 

  • Since the debt to equity ratio will fall, hence beta will also fall.

 

  1. Is using the single WACC figure appropriate for discounting the FCFFs for all years?

 

  • Yes, because initially when the company is deciding on the capital structure it is assumed that this is the optimal capital structure for the company, and hence discounting it for long term is appropriate.
  • WACC reflects the cost of the whole company and FCFF reflects the cash to all the capital holders hence it is the appropriate discount rate.

 

  1. Is an all-equity financing option good for companies? If not, why is Fatima planning to have a no-debt status?

 

  • Where an all-equity financing option may be less riskier than a loan, may add more credibility to your business, while giving you cash on hand for the expansion of the firm, it also gives you the advantage of not being bound to repay.
  • However, at the same time, it poses the threat of a lifelong obligation to the investors as compared to the debt financing when obligations end as soon as the loan is repaid. It also creates the disadvantage of a loss of control and higher regulations.
  • Hence, a blend of the both the financing options, is optimal.

Fatima is going for a no-debt status because it plans to channel its profits towards capital expenditure.

 

Graphs:

graph1

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