Free Cash Flow Based Approaches Questions

Question Description

  1. briefly discuss pros and cons of the three (3) approaches used by analysts to value a company’s equity, namely, the free cash-flow based approaches, earnings-based approaches, and market-based approaches. Please provide numerical examples.
  2. Table 7 and the information that follows the Table 7 about Stiller Corporation financials for the year of 2018 and 2019. Please review the data and follow the instruction:

Table 7

Stiller Corporation Comparative Balance Sheet (2018-2019) in USD

#TEXT20192018
1Cash$157,000$78,000
2Accounts Receivable180,000185,000
3Investments52,00074,000
4Equipment298,000240,000
5Less Accumulated depreciation(106,000)(89,000)
6Current liabilities134,000151,000
7Common Stock160,000160,000
8Retained Earnings287,000177,000

Additional information:

Investments were sold at a loss (not extraordinary) of $7,000; no equipment was sold; cash dividends paid were $50,000; and net income was $160,000.

  1. Prepare a statement of cash flows for 2019 for Stiller Corporation.
  2. Calculate the company’s free cash flow.
  3. Assuming the 2019 cash flows grow at the rates of 20%, 18%, 15% in 2020, 2021, and 2022 respectively, and then stabilizes at 10% calculate the current value of Stiller Corporation. Assume the company’s weighted average cost of capital is 12%.
  4. Booker Inc. is a distributor of building supplies. Management for the company has developed the following forecasts of net income:

Table 8

Forecasted Net Income of Booker Inc. in USD (As of December 31st of each year)

YearForecasted Net Income
2011$111,432
2012$131,490
2013$156,473
2014$178,379
2015$199,784

Management expects net income to grow at a rate of 7% per year after 2015 and the company’s cost of equity capital is 14%. Management has set a dividend payout ratio equal to 25% of net income and plans to continue this policy. Booker’s common shareholders’ equity at January 1, 2011 is $544,902.

  1. Using the residual income model, compute the value of equity of Booker as of January 1, 2011.
  2. Using the dividend discount model, compute the value of equity of Booker as of January 1, 2011.
  3. Compare the results in parts (a) and (b) and discuss possible reasons for any discrepancies

4. Consider the following scenario and complete the last column and then Assess the sensitivity of the price-earnings ratio to changes in the cost of equity capital and changes in the growth rate:

Table 9

Estimating price earning(P/E) ratios under various scenarios

ScenarioCost of Equity CapitalGrowth Rate in EarningsP/E Ratio
10.130.09
20.130.11
30.150.09
40.180.09
50.180.11

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