Reference no: EM132218388

You are an analyst following a manufacturing firm KTB Inc. It has sales of £120 million in 2015. You expect its sales to grow 10% per year over the next two years. Then the sales growth is expected to fall to the industry average of 1%. This is also your estimate of the long-run growth rate of KTB.

In the past, the cost of goods sold was 70% of sales on average. You expect this would be the case for the foreseeable future. Selling and general and administrative expenses are estimated to be 5% of sales.

The firm's net book value of PP&E is £70 million as of 2015 year-end. To meet the expected sales growth, the firm is expected to spend £30 million to expand its production capacity in 2016. To replace wear-and-tear of existing equipment, the firm is expected to invest the amount which is equal to depreciation each year from 2018. For simplicity, you assume that investment is made at year-end. The historical depreciation rate has been 15% of net book value of PP&E. You intend to use this number for your analysis.

The net working capital investment (i.e. change in net working capital) is estimated at 10% of any increase in sales. KTB has a debt of £30 million outstanding in perpetuity, 20 million outstanding shares and a tax rate of 40%. It can borrow or lend at 5% per year. Its equity cost of capital is 10%. Target debt-to-equity ratio is 3.

(Question) Calculate the enterprise value and the fair share value based on the discounted free cash flow model. Explain and justify your answer. (Make assumptions if appropriate to answer the question.) Use the table below if necessary.

                              2015       2016       2017     2018

Sales                     120         132      145.2  146.652

Sales growth                       10%        10%         1%

CoGS                                92.40     101.64    102.66

% of sales                           70%        70%       70%