ABC Ltd.'s share is currently traded at the price of 192.50 per share. Mr. Roni is planning to purchase the shares of the company. For this purpose,…

CA Final · Advanced Financial Management · PYQS · September 2025
ABC Ltd.'s share is currently traded at the price of 192.50 per share. Mr. Roni is planning to purchase the shares of the company. For this purpose, he has taken the services of a financial analyst to know whether the price of ABC Ltd. is fairly priced. The analyst has assembled the following information: The before-tax required rates of return on ABC Ltd. debt, preferred stock, and common stock are 8.60%, 11%, and 13%, respectively.The company's target capital structure is 20% debt, 30% preferred stock and 50% Common stock.The market value of the company's debt is 275 million and its preferred stock are valued at 120 million.ABC Ltd.'s free cash flow to the firm (FCFF) for the year just ended is 125 million. FCFF is expected to grow at a constant rate of 8% for the foreseeable future.The tax rate is 30%.ABC Ltd. has 20 million outstanding common shares. You are required to - (i) As a financial analyst, on the basis of value per share, advise Mr. Roni whether he should purchase the shares of the company at market price or not. (ii) Assume, we are to get same value of equity as calculated in (i) for using FCFE approach, calculate free cash flow to the equity (FCFE) for the year just ended, if FCFE is expected to grow at a constant rate of 8.50% for the foreseeable future. Calculation up to 2 decimal points.

Suggested Answer and Working Notes:

Working Notes: (I) Calculation of WACC = 8.60% (1 – 0.30) x 20% + 11% x 30% + 13% x 50% = 1.20% + 3.30% + 6.50% = 11% (II) Value of Firm based on FCFF = (125Million (1.08)) / (0.11-0.08) = 135 Million / 0.03 = 4500 Million (i) To decide whether the value of share is justified let us compute the value per share based on FCFF as follows: Value of Firm 4500 Million Less: Value of Company's Debt 275 Million Less: Value of Company's Preferred Stock 120 Million Value of Equity Shares 4105 Million No. of Equity Shares 20 Million Value of Per Equity Share 205.25 Advise: Mr. Roni should purchase share at this price as it is underpriced. (ii) Computation of Free Cash Flow to Equity Value of one Equity Share as per FCFF - 205.25 Accordingly, by using Growth Model formula we can find the FCFE per share as follows: 205.25 = FCFE(1.085) / (0.13-0.085) FCFE per share = 8.51 No. of Equity Shares outstanding 20 million FCFE of the ABC Ltd. shall be 8.51 x 20 million = 170.20 million Alternatively, this calculation can be made on the total capital instead of per share basis as follows: 4105 = FCFE(1.085) / (0.13-0.085) FCFE = 170.25 million

Topics: Business Valuation

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