Given the firm's weighted average cost of capital, we implement the discounted free cash flow model in much the same way we did with the bond valuation. That is, we forecast the firm's free cash flow up to some horizon to get the terminal value of the enterprise. The firm's free cash flow up to some horizon is similar to coupons until the maturity date. The firms terminal value is similar to the face value of the bond. However, unlike cash flows from a bond, free cash flows are not the same from period to period. And terminal value is not $1,000, like bond face value. Next, let's learn how to estimate the free cash flows of Yonsei Corporation. Yonsei Corporation had sales of $500 million in 2015. Suppose you expect its sales to grow at a 9% rate in 2016. But at this growth rate, will slow by 1% per year for long-term growth rate for the education industry of 4% by 2021. Based on Yonsei Corporation's past profitability and investment needs, you expect EBIT to be 10% of sales. Increases in net working capital requirements to 9% of any increase in sales. And net investment, which is capital expenditures in excess of depreciation, to be 8% of any increase in sales. Its tax rate is 40% and the weighted average of cost of capital is 12%. Open your Excel template provided it in this class. First of all, 2016 sales is $500 million x 1 + sales growth rate of 9%. So it is $545 million. 2017 sales growth rate is 1% lower than 2016 growth rate of 9%, which is 8%. 2017 sales is 2016 sales times 1 + 2017 sales growth rate. Then 2017 sales is $588.6 million. Now you can copy and paste the growth rate and sales cells up to year 2021. Sales growth rate in 2021 is 4%. It is long-term growth rate. Next, based on the assumption of this example, EBIT is 10% of sales. Multiply $545 million by 10%, which is $54.5 million. Select the cell and then drag the field handle across the cells up to year 2021. Next, Income Tax is 40% of EBIT, which is 21.8. And drag the cells. Then you can estimate the rest of the period. Net investment is 8% of change in sales. 2016 change in sales is 545 minus 500, or 500 times 2016 sales growth rate of 9%. Multiply this number by 8%, which is 3.6. You can do the same for the rest of the estimation period. Increase in net working capital is 9% of change in sales. So 2016 increase in net working capital is $45 million times 9%, which is $4.1 million. You can do the same for the rest of the estimation period. Now you can get Free Cash Flow. FCF is equal to EBIT minus tax minus net investment minus increasing net working capital. For example, 2016 free cash flow is 54.5 minus 21.8 minus 3.6 minus 4.05 is equal to 25.1. You can do the same calculation for the rest of this estimation. 2021 terminal value is present value of 2022 free cash flow, with a permanent growth rate of 4%, discounted at 12%. 2022 free cash flow is (1 + 4%) times $39 million, which is 2021 free cash flow. And this 2022 free cash flow is assumed to grow at 4% permanently. Then present value is 2022 free cash flow / (12%- 4%), which is $506.7 million. As you may have noticed, this is a growing perpetuity. So we can use the present value formula for growing perpetuities that you learned in the previous class. In order to find the present value of total free cash flows, we need to find the total cash flow of each year, which is free cash flow plus terminal value. Lastly, we can find the present value of each total free cash flow separately, as we did in the previous class. However, these cash flows are multiple cash flows. So we can use NPV function to find the present value of the total free cash flow. And this is much easier. In NPV function, the first variable is discount rate. So type in cost of capital, 12%. The second variable is cash flows. Therefore, the present value of total free cash flows for Yonsei Corporation is $385 million. This is exactly same as we got the free cash flows of Yonsei Corporation the previous class. Next, if Yonsei Corporation has $100 million in cash, $50 million in debt, 20 million shares outstanding. What is your estimate of the value of Yonsei Corporation's stock in early 2016? Enterprise value is $385 million. In order to find the value to equity holders, you have to add $100 million of cash to the enterprise value and subtract $50 million from the enterprise value. Next, you have to divide $435 million by 20 million shares to get the price per share. From this calculation, our estimate of the stock price of Yonsei Corporation in early 2016 is $21.75.
