Firm Valuation

Valuation of a Firm

P Ltd. is thinking of acquiring Q Ltd. P’s P/E ratio is 12 and it has a weighted average cost of capital of 14 percent. The financial manager of P has prepared the forecasts for the Q’s operations for the next 10 years. He was not sure about the value of Q’s assets after 10 years. He thought that most of the growth of the business would take place in the first 10 years and thereafter the business might not grow or grow at a very low rate. Q does not employ any debt, and it has 2.5 million outstanding equity shares. Its current P/E ratio is 8 and the equity beta is 1.28. The financial manager argued that the acquisition of Q would contribute to the firm’s debt capacity equal to 30 percent of its value. P will be able to borrow at risk-free rate of 8.5 percent. The risk premium is 9 percent. The corporate tax rate is 35 percent. What is the value of Q?

Forecasts for Q's Operations (Rs in million) 2004 PBDIT 87.59 Capex 52.98 Depreciation 40.17 Change in NWC 24.83

2005 124.55 87.03 54.39 45.66

2006 173.23 119.72 67.27 28.71

2007 155.29 26.22 75.53 12.85

2008 162.99 26.22 79.37 10.28

2004

2005

2006

2007

Actual (Rs in million) PBDIT Less: depreciation PBIT Tax NOPAT Add: depreciation Les: Change in NWC Less: Capex Free cash Flows Terminal Value Net Cash Flows PVF Present value Value of the Firm

2003

55.65 24.85 30.80 10.12 20.68

2009 149.57 16.84 75.53 10.27

2010 161.62 13.42 65.92 10.82

2011 167.66 13.42 52.08 8.66

Forecasts 2008

2009

2010

2012 134.99 6.36 50.54 9.08

2013 129.56 5.68 48.62 6.77

2011

2012

2013