net income is currently 600 million net income will grow by 20 percent annually 543660 | Homework Solutions
An aggressive financial planner who claims to have a superior method for picking undervalued stocks is courting one of your clients. The planner claims that the best way to find the value of a stock is to divide EBITDA by the risk-free bond rate. The planner is urging your client to invest in Alcan, Inc. (NYSE: AL). Alcan is the parent of a group of companies engaged in all aspects of the aluminum business. The planner says that Alcan”s EBITDA of $1,580 million divided by the long-term government bond rate of 7 percent gives a total value of $22,571 million. With 318 million outstanding shares, Alcan”s value per share using this method is $70.98. Shares of Alcan currently trade for $36.50, and the planner wants your client to make a large investment in Alcan through him. A. Provide your client with an alternative valuation of Alcan based on a two-stage FCFE valuation approach. Use the following assumptions:
- Net income is currently $600 million. Net income will grow by 20 percent annually
for the next three years.
- The net investment in operating assets (capital expenditures less depreciation plus investment in working capital) will be $1,150 million next year and grow at 15 percent for the following two years.
- Forty percent of the net investment in operating assets will be financed with net new debt financing.
- Alcan”s beta is 1.3, the risk-free bond rate is 7 percent, and the equity risk premium is 4 percent.
- After three years, the growth rate of net income will be 8 percent and the net investment in operating assets (capital expenditures minus depreciation plus increase in working capital) each year will drop to 30 percent of net income.
- Debt is, and will continue to be, 40 percent of total assets.
- Alcan has 3 18 million outstanding shares. Find the value per share of Alcan.
B. Criticize the valuation approach that the aggressive financial planner used.
