
Concept explainers
Adjusted Cash Flow from Assets [LO3] Ward Corp. is expected to have an EBIT of $1.9 million next year.

To determine: The price per equity share.
Introduction:
Adjusted cash flow from assets refers to the cash flow from assets that excludes the tax benefit obtained from debt financing. It calculates the taxes on the earnings before interest and taxes.
Answer to Problem 24QP
The price per share is $28.20 percent.
Explanation of Solution
Given information:
The EBIT (Earnings before interest and taxes) of Company W is $1,900,000 for the first year. It will have depreciation amounting to $165,000, change in net working capital amounting to $85,000, and capital spending amounting to $115,000. All the estimates will grow at 18 percent for the next four years.
The debt value of the company is $13,000,000, and it has 800,000 shares outstanding. The adjusted cash flow from assets in Year 5 will grow for an indefinite period at 3 percent. The weighted average cost of capital of the company is 8.5 percent, and the tax rate is 35 percent.
The formula to calculate the EBIT from Year 2 to Year 5:
The formula to calculate the depreciation from Year 2 to Year 5:
The formula to calculate the “Taxes*”:
“EBIT” refers to the earnings before interest and taxes
“TC” refers to the corporate tax rate
The formula to calculate the change in net working capital from Year 2 to Year 5:
The formula to calculate the capital spending from Year 2 to Year 5:
The formula to calculate the “CFA*”:
Where,
“CFA*” refers to the adjusted cash flow from assets
“EBIT” refers to the earnings before interest and taxes
“Taxes*” refer to the tax on EBIT
The formula to calculate the terminal value or the value of the company at period “t”:
Where,
“Vt” refers to the terminal value
“CFA*t+1” refers to the adjusted cash flow from assets at the end of period “t+1”
“WACC” refers to the weighted average cost of capital
“g” refers to the growth rate at which the cash flow will grow indefinitely
The formula to calculate the value of the company:
Where,
“V0” refers to the value of the company at present
“CFA*1 to CFA*t” refer to the adjusted cash flow from assets from period 1 to period t
“Vt” refers to the terminal value or the value of the company at period “t”
“WACC” refers to the weighted average cost of capital
The formula to calculate the total value of equity:
The formula to calculate the price per share of the company’s stock:
Compute the EBIT for Year 2:
The EBIT for Year 1 is $1,900,000. The growth rate is 18 percent.
Hence, the EBIT for Year 2 is $2,242,000.
Compute the EBIT for Year 3:
The EBIT for Year 2 is $2,242,000. The growth rate is 18 percent.
Hence, the EBIT for Year 3 is $2,645,560.
Compute the EBIT for Year 4:
The EBIT for Year 3 is $2,645,560. The growth rate is 18 percent.
Hence, the EBIT for Year 4 is $3,121,761.
Compute the EBIT for Year 5:
The EBIT for Year 4 is $3,121,761. The growth rate is 18 percent.
Hence, the EBIT for Year 5 is $3,683,678.
Compute the depreciation for Year 2:
The depreciation for Year 1 is $165,000. The growth rate is 18 percent.
Hence, the depreciation for Year 2 is $194,700.
Compute the depreciation for Year 3:
The depreciation for Year 2 is $194,700. The growth rate is 18 percent.
Hence, the depreciation for Year 3 is $229,746.
Compute the depreciation for Year 4:
The depreciation for Year 3 is $229,746. The growth rate is 18 percent.
Hence, the depreciation for Year 4 is $271,100.
Compute the depreciation for Year 5:
The depreciation for Year 4 is $271,100. The growth rate is 18 percent.
Hence, the depreciation for Year 5 is $319,898.
Compute the “Taxes*”:
Taxes* | |||||
Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | |
EBIT (A) | $1,900,000 | $2,242,000 | $2,645,560 | $3,121,761 | $3,683,678 |
Tax rate (B) | 35% | 35% | 35% | 35% | 35% |
Taxes*(A)×(B) | $665,000 | $784,700 | $925,946 | $1,092,616 | $1,289,287 |
Compute the change in net working capital of Year 2:
The change in net working capital for Year 1 is $85,000. The growth rate is 18 percent.
Hence, the change in net working capital for Year 2 is $100,300.
Compute the change in net working capital of Year 3:
The change in net working capital for Year 2 is $100,300. The growth rate is 18 percent.
Hence, the change in net working capital for Year 3 is $118,354.
Compute the change in net working capital of Year 4:
The change in net working capital for Year 3 is $118,354. The growth rate is 18 percent.
Hence, the change in net working capital for Year 4 is $139,658.
Compute the change in net working capital of Year 5:
The change in net working capital for Year 4 is $139,658. The growth rate is 18 percent.
Hence, the change in net working capital for Year 5 is $164,796.
Compute the capital spending for Year 2:
The capital spending for Year 1 is $115,000. The growth rate is 18 percent.
Hence, the capital spending for Year 2 is $137,500.
Compute the capital spending for Year 3:
The capital spending for Year 2 is $137,500. The growth rate is 18 percent.
Hence, the capital spending for Year 3 is $160,126.
Compute the capital spending for Year 4:
The capital spending for Year 3 is $160,126. The growth rate is 18 percent.
Hence, the capital spending for Year 4 is $188,949.
Compute the capital spending for Year 5:
The capital spending for Year 4 is $188,949. The growth rate is 18 percent.
Hence, the capital spending for Year 5 is $222,959.
Compute the adjusted cash flow from assets “CFA*”:
Adjusted cash flow from assets "CFA*" | |||||
Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | |
EBIT | $1,900,000 | $2,242,000 | $2,645,560 | $3,121,761 | $3,683,678 |
Add: | |||||
Depreciation | $165,000 | $194,700 | $229,746 | $271,100 | $319,898 |
$2,065,000 | $2,436,700 | $2,875,306 | $3,392,861 | $4,003,576 | |
Less: | |||||
Taxes* | $665,000 | $784,700 | $925,946 | $1,092,616 | $1,289,287 |
Capital spending | $115,000 | $135,700 | $160,126 | $188,949 | $222,959 |
Change in Net working capital | $85,000 | $100,300 | $118,354 | $139,658 | $164,796 |
CFA* | $1,200,000 | $1,416,000 | $1,670,880 | $1,971,638 | $2,326,533 |
Compute the terminal value or the value of the company at period “t”:
The adjusted cash flow from assets in year 5 is $2,326,533. The weighted average cost of capital is 8.5 percent. The adjusted cash flow from assets will grow at 3 percent for an indefinite period.
Hence, the terminal value at Year 5 is $43,569,618.
Compute the value of the company:
The adjusted cash flow from assets for Year 1, Year 2, Year 3, Year 4, and Year 5 are $1,200,000, $1,416,000, $1,670,880, $1,971,638, and $2,326,533. The terminal value is $43,569,618. The weighted average cost of capital is 8.5 percent.
Hence, the value of the company is $35,562,673.40.
Compute the total value of equity:
Hence, the total value of equity is $22,562,673.40.
Compute the price per share of the company’s stock:
Hence, the price per share is $28.20.
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Chapter 14 Solutions
Fundamentals of Corporate Finance
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