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    Module 3 Activity 2

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    Lezi Woo
    The document discusses stock valuation and free cash flow valuation. It provides examples of using the constant growth model and Gordon growth model to calculate stock prices given dividend growth rates and required rates of return. It also works through an example of valuing a company called Humtha Industries using its free cash flows over 5 years, an expected long-term growth rate, and weighted average cost of capital to determine the total firm value, common stock value, and estimated per share value.

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    Module 3 Activity 2

    Uploaded by

    Lezi Woo
    30 views5 pages
    The document discusses stock valuation and free cash flow valuation. It provides examples of using the constant growth model and Gordon growth model to calculate stock prices given dividend growth rates and required rates of return. It also works through an example of valuing a company called Humtha Industries using its free cash flows over 5 years, an expected long-term growth rate, and weighted average cost of capital to determine the total firm value, common stock value, and estimated per share value.

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    MODULE 3 ACTIVITY 2

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    The document discusses stock valuation and free cash flow valuation. It provides examples of using the constant growth model and Gordon growth model to calculate stock prices given dividend growth rates and required rates of return. It also works through an example of valuing a company called Humtha Industries using its free cash flows over 5 years, an expected long-term growth rate, and weighted average cost of capital to determine the total firm value, common stock value, and estimated per share value.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    30 views5 pages

    Module 3 Activity 2

    Uploaded by

    Lezi Woo
    The document discusses stock valuation and free cash flow valuation. It provides examples of using the constant growth model and Gordon growth model to calculate stock prices given dividend growth rates and required rates of return. It also works through an example of valuing a company called Humtha Industries using its free cash flows over 5 years, an expected long-term growth rate, and weighted average cost of capital to determine the total firm value, common stock value, and estimated per share value.

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    © All Rights Reserved
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    Download as docx, pdf, or txt
    of 5

    MODULE 3 ACTIVITY FINANCIAL MANAGEMENT MBA 2

    ACTIVITY 2: STOCK VALUATION


    I. Common Stock Value- Constant Growth
             Mckapoy Corporation, common stock paid a dividend of P12.50 per share last year. The
    company expects earnings and dividends to grow at 6% per year for the foreseeable future
    year
    a. What is the value of the stock if the required rate of return is 12.5% per year?
    Formula: Value of Stock = ________Dividend of Share_________
    Rate of Return – Growth Rate
    Given: Dividend of Share: P12.50
    Rate of Return: 12.5% or 0.125
    Growth Rate: 6% or 0.06

    Value of Stock = ____P12.50____


    0.125 – 0.06

    Value of Stock = P 192.31

    b. What is the required rate of return for this stock would result in a price per share of
    P250?
    Formula: Value of Stock = ________Dividend of Share_________
    Rate of Return – Growth Rate

    Rate of Return = __Dividend of Share__ + Growth Rate


    Value of Stock

    Given: Dividend of Share: P12.50


    Value of Stock: P250
    Growth Rate: 6% or 0.06

    Rate of Return = __P12.50__ + 0.06


    P250

    Rate of Return = 0.05 + 0.06

    = 0.11 or 11%

    II. Common Stock Value- All growth models 


           You are evaluating the potential purchase of a small business currently giving out
    dividend per share of P4.25. On the basis of a review of similar-risk investment opportunities,
    you must earn an 18% rate of return on the proposed purchase. Because you are relatively
    uncertain about future cash flows, you decide to estimate the firm’s value using several
    possible assumptions about the growth rate of cash flows: 
    a. What is the firm’s value of stock if expected to grow at an annual rate of 0% from now
    to infinity? 
    Formula: Value of Stock = ________Dividend of Share_________
    Rate of Return – Growth Rate
    Given: Dividend of Share: P 4.25
    Rate of Return: 18% or 0.18
    Growth Rate: 0% or 0.00

    Value of Stock = ____P4.25____


    0.18 – 0.00
    Value of Stock = P 23.61
    b. What is the firm’s value of stock if dividends are expected to grow at a constant rate
    of 8% from now to infinity?
    Formula: Value of Stock = ________Dividend of Share_________
    Rate of Return – Growth Rate
    Given: Dividend of Share: P 4.25
    Rate of Return: 18% or 0.18
    Growth Rate: 8% or 0.08

    Value of Stock = ____P4.35____


    0.18 – 0.08
    Value of Stock = P 42.50
    c. What is the firm’s value of stock if dividends are expected to grow at an annual rate of
    15% for the first 3 years, 12% for the next 2 years and followed by a constant annual
    rate of 8% from 6 years to infinity? 
      Value of stock dividends for the first three years, growing at 15% annually:
    Year 1 dividend: P4.25 * (1 + 0.15) = P4.89
    Year 2 dividend: P4.89 * (1 + 0.15) = P5.62
    Year 3 dividend: P5.62 * (1 + 0.15) = P6.46
    Value of stock dividends for the next two years, growing at 12% annually:
    Year 4 dividend: P6.46 * (1 + 0.12) = P7.25
    Year 5 dividend: P7.25 * (1 + 0.12) = P8.12
    Value of stock dividends from year 6 to infinity, growing at a constant rate of 8%
    annually:
    Year 6 dividend: P8.12 * (1 + 0.08) = P8.78
    Year 7 dividend: P8.78 * (1 + 0.08) = P9.49
    Value of stocks in infinite series of dividends:
    P8.78 / (0.18 - 0.08) + P9.49 / (0.18 - 0.08) + P9.49 / (0.18 - 0.08)2 + ...
    Value of dividend payments using the Gordon Growth Model:
    Value of Stock = (P4.89 / (1 + 0.18)) + (P5.62 / (1 + 0.18)2) + (P6.46 / (1 + 0.18)3)
    + (P7.25 / (1 + 0.18)4) + (P8.12 / (1 + 0.18)5) + (P8.78 / (0.18 - 0.08)) + (P9.49 /
    (0.18 - 0.08)) + (P9.49 / (0.18 - 0.08)2) + ...

    III. Free Cash Flow Valuation


    Humtha Industries is considering going public but is unsure of a fair offering price for
    the company. The firm’s CFO has gathered data for performing the valuation using the free
    cash flow valuation model. The firm’s weighted average cost of capital is 11% and it has P1.5
    million of debt at market value and P500,000 of preferred stock at its assumed market value.
    The estimated free cash flows over the next 5 years 2016 through 2020 are given below.
    Beyond 2020 to infinity, the firm expects its free cash flow to grow by 3% annually. 

    2016 - P 250,000 2019 - P 450,000

    2017 -    320,000 2020 -     480,000

    2018 -    400,000

    Required: 
    Using the free cash flow valuation method, estimate the value of Humtha Industries’ entire
    company, the total value of Common Stock and the estimated value per share assuming the
    firm plants to issue 250,000 shares of common stock.

    Given:
    Year FCFt Other Data
    2016 P 250,000 Growth Rate of FCFt, beyond 2020 to infinity: 3% or 0.03
    2017 P 320,000 WACC: 11% or 0.11
    2018 P 400,000 Market Value of Debt: P 1.5 Million
    2019 P 450,000 Market Value of Preferred Stock: P 500,000
    2020 P 480,000 No. of Shares of Common Stock: 250,000

    Answer:
    Present value of free cash flow occurring from the end of 2021 to infinity, measured at
    the end of 2020:
    Value of FCF2020 → ∞ = __FCF2021__
    ra – gFCF
    = __P 480,000 ( 1 + 0.03 )__
    0.11 – 0.03
    = __P 494,400__
    0.08
    = P 6,180,000
    Total FCF of 2020:
    Total FCF2020 = 2020 FCF + Value of FCF from 2021 to infinity
    = P 480,000 + P 6,180,000
    = P 6,660,000

    Value of Entire Company: Sum of Present Values of FCFs for 2016 through 2020, VC:
    VC = ____FCFt_____ + ____FCFt_____ + ...
    (1+WACC) (1+WACC)2
    VC = P 250,000 + P 320,000 + P 400,000 + P 450,000 + P 480,000
    (1.11) (1.11)2 (1.11)3 (1.11)4 (1.11)5
    = P 225,225 + P 259,719 + P 292,477 + P 296,429 + P 284,857
    = P 1,358,707

    Value of Common Stock:


    Vs = VC + VD + VP

    Where: VC = Value of Entire Company


    VD = Market Value of Debt
    VP = Market Value of Preferred Stock

    Vs = P 1,358,707 + P 1,500,000 + P 500,000


    = P 3,358,707
    Estimate Value per Share:
    Price = Vs ÷ No. of Shares
    = P 3,358,707 ÷ 250,000
    = P 13.43

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