Question

Assume that today is December 31, 2019, and that the following information applies to Abner Airlines: After-tax operating income [EBIT(1 - T)] for 2020 is expected to be $700 million. The depreciation expense for 2020 is expected to be $150 million. The capital expenditures for 2020 are expected to be $375 million. No change is expected in net operating working capital. The free cash flow is expected to grow at a constant rate of 7% per year. The required return on equity is 13%. The WACC is 11%. The firm has $199 million of non-operating assets. The market value of the company's debt is $3.534 billion. 120 million shares of stock are outstanding. Using the corporate valuation model approach, what should be the company's stock price today

Answer 1

Answer:

The company's stock price today should be $71.17 per share.

Explanation:

The corporate valuation model approach can be used to estimate this by using the following steps:

Step 1: Calculation of the free cash flow

Free cash flow is the cash a firm generates after accounting for capital expenditure. This can be estimated using the following formula:

Free Cash Flow (FCF) = After-tax operating income + Depreciation expenses - Capital expenditure

For this question, we therefore have:

Free Cash Flow (FCF) = $700 + $150 - $375 = $475 million

Step 2: Calculation of Value of operations (Vo)

Vo = FCF / (WACC - FCF growth rate) = 475 / (11% - 7%) = $11,875 million

Step 3: Calculation of the Firm value

Firm value = Vo + Non-operating assets = $11,875 + $199 = $12,074 million

Step 4: Calculation of value of equity

Value of equity = Firm value - Debt = $12,074 - $3,534 = $8,540 million

Note: The correct amount of debt is $3,534 not $3.540 as mistakenly given, may be due to typographical error, in the question.

Step 5: Calculation of stock price per share today

Stock price per share = Value of equity / Number of shares outstanding = $8,540 / 120 = $71.17 per share

Therefore, the company's stock price today should be $71.17 per share.