Chapter 18, Problem 16PS

a.

Summary Introduction

To calculate:The intrinsic value when GE’s P/E ratio starting in 2020 will be 16.

Introduction:

Unlevered Beta: This is also called as asset beta. It is one of the risk measurement unit which is used to compare the risk of company that doesnot have any debts with that of risk of the markets. In other words, risk of the company without dedts and risk of the market is compared.$IntrinsicValueofStock=\frac{IntrinsicvalueofBusiness}{No.ofOutstandingShares}$

  $IntrinsicvalueofBusiness=\frac{FCF{E}_1}{{\left(1+r\right)}^1}+\frac{FCF{E}_2}{{\left(1+r\right)}^2}+\dots \dots \dots \mathrm{..}+\frac{Terminalvalue}{{\left(1+r\right)}^n}$

Answer to Problem 16PS

The intrinsic value when P/E ratio in the year 2020 is 16 will be $111868 and of FCFE will be $77595.80.

Explanation of Solution

Given information:

Spreadsheet 18.2 − Free cash flow model

		2016	2017	2018	2019	2020
A.Input data
P/E		14.35	14.25	14.17	14.08	14
Cap spending'shr		2.65	2.7	2.82	2.93	3.05
LT Debt		30000	28500	27333	26167	25000
Shares		1800	1800	1798	1797	1795
EPS		3.1	3.75	3.83	3.92	4
Working capital		36825	37750	41173	44597	48020
Discount rate calculations
Current beta	0.95
unlevered beta	0.767
terminal growth	0.02
tax_rate	0.35
r.debt	0.036
risk-free rate	0.02
market risk premium	0.08

The formulas to be entered in the cells are as follows:

  

  

After inputing the required value in the cell related to G3, we get the following values.

  

  

  

Therefore the intrinsic value when P/E ratio in the year 2020 is 16 will be $111868 and of FCFE will be $77595.80

b.

Summary Introduction

To calculate: The intrinsic value when GE’s unlevered beta is 0.80.

Introduction:

Unlevered Beta: This is also called as asset beta. It is one of the risk measurement unit which is used to compare the risk of company that doesnot have any debts with that of risk of the markets. In other words, risk of the company without dedts and risk of the market is compared.$IntrinsicValueofStock=\frac{IntrinsicvalueofBusiness}{No.ofOutstandingShares}$

  $IntrinsicvalueofBusiness=\frac{FCF{E}_1}{{\left(1+r\right)}^1}+\frac{FCF{E}_2}{{\left(1+r\right)}^2}+\dots \dots \dots \mathrm{..}+\frac{Terminalvalue}{{\left(1+r\right)}^n}$

Answer to Problem 16PS

The intrinsic value of FCFF is $113972 and FCFE is $79038.50.

Explanation of Solution

Given information:

Spreadsheet 18.2 − Free cash flow model

		2016	2017	2018	2019	2020
A.Input data
P/E		14.35	14.25	14.17	14.08	14
Cap spending'shr		2.65	2.7	2.82	2.93	3.05
LT Debt		30000	28500	27333	26167	25000
Shares		1800	1800	1798	1797	1795
EPS		3.1	3.75	3.83	3.92	4
Working capital		36825	37750	41173	44597	48020
Discount rate calculations
Current beta	0.95
unlevered beta	0.767
terminal growth	0.02
tax_rate	0.35
r.debt	0.036
risk-free rate	0.02
market risk premium	0.08

The formulas to be entered in the cells are as follows:

  

  

  

We need to change the vaue of unlevered beta from 0.767 to 0.80. After inputing the required value in the cell related to B22, we get the following values.

  

  

Therefore, the intrinsic value of FCFF is $113972 and FCFE is $79038.50.

c.

Summary Introduction

To calculate: Intrinsic value when the market risk premium is 7.5%

Introduction:

Unlevered Beta: This is also called as asset beta. It is one of the risk measurement unit which is used to compare the risk of company that doesnot have any debts with that of risk of the markets. In other words, risk of the company without dedts and risk of the market is compared.$IntrinsicValueofStock=\frac{IntrinsicvalueofBusiness}{No.ofOutstandingShares}$

  $IntrinsicvalueofBusiness=\frac{FCF{E}_1}{{\left(1+r\right)}^1}+\frac{FCF{E}_2}{{\left(1+r\right)}^2}+\dots \dots \dots \mathrm{..}+\frac{Terminalvalue}{{\left(1+r\right)}^n}$

Answer to Problem 16PS

The intrinsic value of FCFF will be$ 119921 and for FCFE it will be $83151.40.

Explanation of Solution

Given information:

Spreadsheet 18.2 − Free cash flow model

		2016	2017	2018	2019	2020
A.Input data
P/E		14.35	14.25	14.17	14.08	14
Cap spending'shr		2.65	2.7	2.82	2.93	3.05
LT Debt		30000	28500	27333	26167	25000
Shares		1800	1800	1798	1797	1795
EPS		3.1	3.75	3.83	3.92	4
Working capital		36825	37750	41173	44597	48020
Discount rate calculations
Current beta	0.95
unlevered beta	0.767
terminal growth	0.02
tax_rate	0.35
r.debt	0.036
risk-free rate	0.02
market risk premium	0.08

The formulas to be entered in the cells are as follows:

  

  

  

We need to change the vaue of unlevered beta from 0.08 to 0.075. After inputing the required value in the cell related to B27, we get the following values.

  

  

Therefore the intrinsic value of FCFE will be$ 119921 and for FCFE it will be $83151.40.