A buy-side analyst has been asked by her fund manager for advice as to whether they should
Question:
A buy-side analyst has been asked by her fund manager for advice as to whether they should add stocks of ABC Plc to their portfolio. The stock is currently trading at £260. The analyst decides to use the Discounted Free Cash Flow to the Firm (FCFF) valuation model, and collects the following data for the year just ended:
EBITDA: £540m
Depreciation and amortisation: £60m
Net interest expense: £45m
Effective tax rate: 25%
The working capital has increased from £45m at the beginning of the year to £65m at the year-end
Investment in fixed capital: £90m
Current market value of the outstanding debt: £1,500m
Number of shares outstanding: 10m
The company's target capital structure is 30% debt and 70% equity
Before-tax cost of debt: 7%
Risk free rate: 4%
The expected return of the market: 9%
The stock's beta: 1.2
The analyst forecasts that the FCFF and EBITDA will grow at 8% per annum over the next
three years. Due to uncertainty beyond this three-year forecast horizon, the analyst decides
to estimate the terminal value (at the forecast horizon) by using the sector's historic-average
EV/EBITDA (Enterprise Value-to-EBITDA) multiple of 6.
Reminder of the FCFF formula:
FCFF = After tax earnings + Net Noncash Charges + Interest Expense x (1- tax rate) - Fixed
Capital Investment - Working Capital Investment
REQUIRED:
Provide an investment recommendation based on your valuation of ABC Plc's stock. Please show your workings (computations should be rounded off to one decimal place).
Financial Markets And Institutions
ISBN: 978-0132136839
7th Edition
Authors: Frederic S. Mishkin, Stanley G. Eakins