LOS e: Calculate FCFF and FCFE given a company's financial statements, prepared according to U.S. generally accepted accounting principles (GAAP) or International Financial Reporting Standards (IFRS).

Q1. SOX Inc. expects high growth in the next 4 years before slowing to a stable future growth of 3%. The firm is assumed to pay no dividends in the near future and has the following forecasted free cash flow to equity (FCFE) information on a per share basis in the high-growth period:

High-growth period assumptions:

• SOX Inc.'s target debt ratio is 40% and a beta of 1.3.
• The long-term Treasury Bond Rate is 4.0%, and the expected equity risk premium is 6%.

Stable-growth period assumptions:

• SOX Inc.'s target debt ratio is 40% and a beta of 1.0.
• The long-term Treasury Bond Rate is 4.0% and the expected equity risk premium is 6%.
• Capital expenditures are assumed to equal depreciation.
• In year 5, earnings are $8.10 per share while the change in working capital is $2.00 per share.
• Earnings and working capital are expected to grow by 3% a year in the future.

In year 5, what is the free cash flow to equity (FCFE) for SOX Inc.?

A)   $7.30.

B)   $6.90.

C)   $6.10.

Q2. A firm currently has sales per share of $10.00, and expects sales to grow by 25% next year. The net profit margin is expected to be 15%. Fixed capital investment net of depreciation is projected to be 65% of the sales increase, and working capital requirements are 15% of the projected sales increase. Debt will finance 45% of the investments in net capital and working capital. The company has an 11% required rate of return on equity. What is the firm’s expected free cash flow to equity (FCFE) per share next year under these assumptions?

A)   $0.77.

B)   $0.38.

C)   $1.88.

Q3. Using the information below, value the stock of Symphony Publishing, Inc. using the free cash flow from equity (FCFE) valuation method.

§         Required return of 13.0%.

§         Value at the end of year 3 of 13 times FCFE₃.

§         Shares outstanding: 10.0 million.

§         Net income in year 1 of $10.0 million, projected to grow at 10% for the next two years. 

§         Depreciation per year of $3.0 million.

§         Capital Expenditures per year of $2.5 million.

§         Increase in working capital per year of $1.0 million.

• Principal repayments on debt per year of $1.5 million.

The value per share of Symphony Publishing is approximately:

A)   $112.10.

B)   $14.10.

C)   $11.21.

Q4. The following information pertains to the Harrisburg Tire Company (HTC) in 2000.

• Earnings (net income) = $600M.
• Dividends = $120M.
• Interest expense = $400M.
• Tax rate = 40%.
• Depreciation = $500M.
• Capital spending = $800M.
• Total assets = $10B (book value and market value).
• Debt = $4B (book value and market value).
• Equity = $6B (book value and market value).

The firm's working capital needs are negligible, and they plan to continue to operate at their current capital structure.

The free cash flow to the firm is:

A)   $420M.

B)   $300M.

C)   $540M.

Q5. A firm currently has the following per share values:

• Cash flow from operations (CFO) is $49.50.
• Investment in fixed capital is $40.00.
• Net borrowing is $7.50.

What is the current per share free cash flow to equity (FCFE)?

A)   $17.00.

B)   $97.00.

C)   $16.50.

Q6. Harrisburg Tire Company (HTC) forecasts the following for 2007.

• Earnings (net income) = $600M.
• Dividends = $120M.
• Interest expense = $400M.
• Tax rate = 40%.
• Depreciation = $500M.
• Capital spending = $800M.
• Total assets = $10B (book value and market value).
• Debt = $4B (book value and market value).
• Equity = $6B (book value and market value).

The firm's working capital needs are negligible, and they plan to continue to operate at their current capital structure.

The firm's estimated earnings growth rate is:

A)   4.8%.

B)   8.0%.

C)   6.4%.

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