Reference no: EM132902684
Question - John Smith, a sell-side analyst covering ABC plc, is updating his valuation and price target of ABC's stock for a research report that he is about to disseminate to clients. John decides to use the Discounted Free Cash Flow to the Firm (FCFF) valuation model, and collects the following information for the year just ended:
Sales: £550m
Net profit margin: 20%
Depreciation expense: £35m
Net investment in fixed capital: £40m
Net interest expense: £12.5m
The working capital has increased from £12.5m at the beginning of the year to £17.5m at the year-end Effective tax rate: 30%
Current market value of the outstanding debt: £700m
Number of shares outstanding: 5m
The company's target capital structure is 40% debt and 60% equity.
Before-tax cost of debt: 7%
Risk free rate: 4%
The expected return of the market: 9%
The stock's beta: 1.2
The historic-average EV/Sales (i.e. Enterprise Value-to-Sales) multiple of ABC plc's sector is 3.
ABC plc's current P/E(price-to-earnings) multiple is 15
John forecasts that the FCFF and Sales will grow at 5% per annum over the next three years and decides to use this period as his forecast horizon. To estimate the terminal value of the enterprise at the forecast horizon, he decides to use the sector's historical average EV/Sales multiple (i.e. the method of comparables).
REQUIRED - Estimate the one-year forward price target for ABC plc stock using the FCFF valuation approach, and state and justify your investment recommendation. You must show your workings and accompany your workings with brief verbal annotations. Computations should be rounded to one decimal place.