Intelligent Semiconductor: Free Cash Flow to Equity Valuation

Value per Share of Intelligent Semiconductor

Prev Question Next Question

Question

A junior financial analyst with Churn Brothers brokerage has been instructed to value shares of Intelligent Semiconductor, a diversified technology company. A senior analyst at Churn Brothers has provided the following information:

The required rate of return on equity is 15% per year

The senior analyst has predicted that shares of Intelligent will sell at a multiple of 25 times predicted free cash flow to equity in four years.

The estimated free cash flows for each of the next four years are:

Year 1: $15,000,000 -

Year 2: $18,500,000 -

Year 3: $21,000,000 -

Year 4: $35,000,000 -

Intelligent Semiconductor has 1,000,000 shares of common stock outstanding.

Using this information, what is the value per share of Intelligent Semiconductor according to the free cash flow to equity model?

Answers

Explanations

Click on the arrows to vote for the correct answer

A. B. C. D. E. F.

B

When determining the value of a common stock using the free cash flow to equity model, it is necessary to determine three things:

1. The required rate of return on equity investments.

2. The estimated free cash flow to equity multiple at time "k."

3. The estimated free cash flows figures for the time periods leading up to "k."

In this example, the calculation must begin with the discounting the free cash flow to equity figures for each of the four years provided. These figures are discounted each period by the required return on equity investments, and the final answer is converted to a per-share basis. This process is illustrated below:

Year 1: ($15,000,000 / 1.15) / 1,000,000 shares outstanding = $13.04

Year 2: [$18,500,000 / (1.15)(1.15)] / 1,000,000 shares outstanding = $13.99

Year 3: [$21,000,000 / (1.15)(1.15)(1.15)] / 1,000,000 shares outstanding = $13.81

Year 4: [$35,000,000 / (1.15)(1.15)(1.15)(1.15)] / 1,000,000 shares outstanding = $20.01

Now that the free cash-flow-to-equity figures have been discounted and converted to a per-share basis, the next step in the valuation process is to determine the value of the final cash flow, which is defined as:

[(Free cash flow to equity multiple * Final free cash flow) / (1 + r)(1+r)...(1 + k)]

In the body of this question, we were given the anticipated multiple of free cash to equity that shares of Intelligent Semiconductor will sell for at time period 4: 25 times. Imputing this information into the terminal cash flow equation will yield the following:

{[25 * ($35,000,000 / 1,000,000 shares outstanding)] / [(1.15) (1.15)(1.15)(1.15)]} = $500.28.

Adding the answers from step 1 to the final year cash flow will yield the following:

Value of Intelligent Semiconductor = [$13.04 + $13.99 + $13.81 + $20.01 + $500.28] = $561.13 per share.

Prev Question Next Question