A financial planner who claims to have a superior method for picking stocks is attempting to lure one of your clients away from you. He claims the best way to find the value of a stock is to divide EBITDA by the risk-free bond rate. He is urging your client to invest in Jeitu Inc. The planner says that Jeitu’s EBITDA of $1,580 million divided by the long-term government bond rate of 7% equals a total value of $22,571.4 million. With 318 million shares outstanding, Jeitu’s value per share using this method is $70.98. Jeitu’s shares currently trade at $36.50. a. Provide your client with an alternative estimate of value based on a two-stage FCFE valuation approach. Use the following assumptions: • Net income is currently $600 million. Net income will grow by 20% annually for the next three years. • The net investment in operating assets (capital expenditures less depreciation plus investment in working capital) will be $1,150 million next year and grow at 15% for the following two years. • Forty percent of the net investment in operating assets will be financed with new debt financing. • Jeitu’s beta is 1.3; the risk-free rate is 7%; the equity risk premium is 4%. • After three years, the growth rate of net income will be 8% and the net investment in operating assets each year will drop to 30% of net income. • Debt is and will continue to be 40% of total assets. • Jeitu has 318 million shares outstanding. b. List what is wrong with the valuation approach used by the financial planner trying to lure your client away from you.
A financial planner who claims to have a superior method for picking stocks is attempting to lure one of your clients away from you. He claims the best way to find the value of a stock is to divide EBITDA by the risk-free bond rate. He is urging your client to invest in Jeitu Inc. The planner says that Jeitu’s EBITDA of $1,580 million divided by the long-term government bond rate of 7% equals a total value of $22,571.4 million. With 318 million shares outstanding, Jeitu’s value per share using this method is $70.98. Jeitu’s shares currently trade at $36.50. a. Provide your client with an alternative estimate of value based on a two-stage FCFE valuation approach. Use the following assumptions: • Net income is currently $600 million. Net income will grow by 20% annually for the next three years. • The net investment in operating assets (capital expenditures less depreciation plus investment in working capital) will be $1,150 million next year and grow at 15% for the following two years. • Forty percent of the net investment in operating assets will be financed with new debt financing. • Jeitu’s beta is 1.3; the risk-free rate is 7%; the equity risk premium is 4%. • After three years, the growth rate of net income will be 8% and the net investment in operating assets each year will drop to 30% of net income. • Debt is and will continue to be 40% of total assets. • Jeitu has 318 million shares outstanding. b. List what is wrong with the valuation approach used by the financial planner trying to lure your client away from you.
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
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A financial planner who claims to have a superior method for picking stocks is attempting to lure one of your clients away from you. He claims the best way to find the value of a stock is to divide EBITDA by the risk-free bond rate. He is urging your client to invest in Jeitu Inc. The planner says that Jeitu’s EBITDA of $1,580 million divided by the long-term government bond rate of 7% equals a total value of $22,571.4 million. With 318 million shares outstanding, Jeitu’s value per share using this method is $70.98. Jeitu’s shares currently trade at $36.50.
a. Provide your client with an alternative estimate of value based on a two-stage FCFE valuation approach. Use the following assumptions:
• Net income is currently $600 million. Net income will grow by 20% annually for the next three years.
• The net investment in operating assets (capital expenditures less depreciation plus investment in working capital) will be $1,150 million next year and grow at 15% for the following two years.
• Forty percent of the net investment in operating assets will be financed with new debt financing.
• Jeitu’s beta is 1.3; the risk-free rate is 7%; the equity risk premium is 4%.
• After three years, the growth rate of net income will be 8% and the net investment in operating assets each year will drop to 30% of net income.
• Debt is and will continue to be 40% of total assets.
• Jeitu has 318 million shares outstanding.
b. List what is wrong with the valuation approach used by the financial planner trying to lure your client away from you.
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