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Prof. Mark Roe brings up the following issues:
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We first compute Taxable Income as Revenue less COGS less SG&A less Depreciation; we then multiply it by (1-tax rate) to get Unlevered Income. (The implicit assumption is that Depreciation is not included in COGS or in SG&A.) We then add back Depreciation to get Free Cash Flow (FCF).
2010 2011 2012 2013 Revenue 25 28 33 40 COGS 20 22.4 26.4 32 SG&A 2 2 3 4 Depreciation 2 2.24 2.64 3.2 EBIT 1 1.36 0.96 0.8 Taxes 0.35 0.476 0.336 0.28 Unlevered Income 0.65 0.884 0.624 0.52 FCF 2.65 3.124 3.264 3.72 Present Value 2.30435 3.124 3.264 3.72 The required rate of return is computed using the CAPM as 3 + 1.5(8) = 15%
The last line of the table computes the present value of the FCF each year using the 15% discount rate. Adding them up, we get $12.412 million. However, we need to subtract from this, the initial investment requirements of $5m plus $1m for working capital, which gives us $12.412-$6 = $6.412. To this, we add the present value of the working capital that can be recovered at the end of 2013, 1/(1.15)4, or $0.5718m. This gives us a NPV of $6.9841m.
Note: Don't ask me how an initial investment of $5m. allows for a total depreciation of $12.24 over the four years! IRS accounting rules :-)
3.
Date |
Close |
Return |
Deviation |
Sq Dev |
5/1/2009 | 5.88 | -0.01672 | -0.13659 | 0.018656 |
4/1/2009 | 5.98 | 1.273764 | 1.153899 | 1.331484 |
3/2/2009 | 2.63 | 0.315 | 0.195135 | 0.038078 |
2/2/2009 | 2 | 0.069519 | -0.05035 | 0.002535 |
1/2/2009 | 1.87 | -0.18341 | -0.30327 | 0.091973 |
12/1/2008 | 2.29 | -0.1487 | -0.26856 | 0.072127 |
11/3/2008 | 2.69 | 0.228311 | 0.108446 | 0.01176 |
10/1/2008 | 2.19 | -0.57885 | -0.69871 | 0.488197 |
9/3/2008 | 5.2 |
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The article does not necessarily contradict Prof. PV. First of all, the stock price had previously already factored in the value of any potential acquisitions, as mentioned in the article (that the stock had jumped 22%). The new stock issue would have the impact of reducing the firm's leverage (Peter Chu said the net gearing would fall sharplyl), which might be seen as too low by the market. Finally, the very low price at which the new equity was placed provides new -- and negative -- information regarding the value of the stock.