Free Cash Flow to Equity Model Valuation

The assignment utilizes the Free Cash Flow to Equity Model to value a share that has been acquired. The intrinsic value of the share is calculated to be $4.18, which is significantly higher than its market value of $0.39. Sensitivity analysis reveals that a dividend growth rate of 2% and required rate of return of 2.96% result in the highest share value. The assignment provides a detailed step-by-step process of applying the Free Cash Flow to Equity Model and highlights its importance in valuation.

Running head: INVESTMENT
Investment
Name of the Student:
Name of the University:
Author Note

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Table of Contents
Part 1................................................................................................................................................2
Capital Asset Pricing Model (CAPM) Estimation.......................................................................2
Risk Free Rate of return...............................................................................................................2
Estimated Beta.............................................................................................................................2
Part 2................................................................................................................................................4
Dividend valuation model............................................................................................................4
Free Cash Flow to Equity Model.................................................................................................6
References........................................................................................................................................8

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Part 1
Capital Asset Pricing Model (CAPM) Estimation
The Capital Asset Pricing model refers to the particular model that describes the link
between the systematic risk and expected return for assets especially the stocks. This particular
model is used for determining the value of the risky securities.
Computation of Cost of Capital:
Particulars Amount
Beta
0.066423
7
Systematic Risk
0.666666
7
Unsystematic Risk
0.333333
3
Adjusted Beta
0.377615
8
Market Return 5.25%
Risk Free Rate 2.37%
Market Risk Premium 2.88%
Cost of Capital under CAPM 3.46%
The assumptions that have been undertaken for the computation of the above cost of
capital are that the rate of the systematic and unsystematic risk has been assumed to be
0.6666667 and 0.3333333.
Risk Free Rate of return
The risk free rate of return has been provided and is 2.37%.
Estimated Beta
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.215316

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R Square 0.046361
Adjusted R
Square 0.029919
Standard
Error 0.030706
Observation
s 60
ANOVA
df SS MS F
Significan
ce F
Regression 1 0.002659
0.00265
9
2.81966
8 0.098496
Residual 58 0.054685
0.00094
3
Total 59 0.057343
Coefficien
ts
Standard
Error t Stat P-value
Lower
95%
Upper
95%
Lower
95.0%
Upper
95.0%
Intercept 0.00159 0.004112
0.38675
6
0.70035
2 -0.00664
0.00982
2
-
0.0066
4
0.00982
2
X Variable 1 0.066424 0.039557
1.67918
7
0.09849
6 -0.01276
0.14560
6
-
0.0127
6
0.14560
6
-0.3 -0.2 -0.1 0 0.1 0.2 0.3 0.4 0.5
-0.15
-0.1
-0.05
0
0.05
0.1
X Variable 1 Residual Plot
X Variable 1
Residuals

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-0.3 -0.2 -0.1 0 0.1 0.2 0.3 0.4 0.5
-0.15
-0.1
-0.05
0
0.05
0.1
X Variable 1 Line Fit Plot
Y
Predicted Y
X Variable 1
Y
0 20 40 60 80 100 120
-0.15
-0.1
-0.05
0
0.05
0.1
Normal Probability Plot
Sample Percentile
Y
Part 2
The second section of the assignment deals with the estimation of the value of the shares
of the company. The different models that have been utilized for carrying out the valuation of the
shares of the company are as follows:
 Dividend valuation model (DDM)
 Free Cash Flow to Equity model (FCEE)
Dividend valuation model
The Dividend valuation model refers to that particular model that defines the method for
carrying out the valuation of the stocks of the company on the basis of the theory that the value
of the stocks of the company is equal to the total worth of the sum of the future dividend
payments after discounting them to their present values. To be precise, this particular model is
utilized for valuing the stocks on the basis of the net present value of the dividends (Lazzati and
Menichini 2015).

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The dividend valuation model or the dividend discount model has been necessarily
derived from the formula in relation to the present value of a perpetuity. The variables that have
been included in the equation are the dividend per share, the discount rate and the estimated rate
in regards to the growth of dividend.
Dividend Discount Model Calculation:
Curre
nt Forecast
FY Ending 2017 2018 2019 2020 2021
2022
Onwards
Time Period 0 1 2 3 4 5
Dividend Model
Multi-
Stage
Multi-
Stage
Multi-
Stage
Multi-
Stage
Gordon
Growth
Retention Rate
70.29
% 70.29% 70.29% 70.29% 70.29% 70.29%
ROE
13.42
% 18.92% 18.92% 24.42% 24.42% 19.92%
Dividend Growth Rate 0.50% 0.62% 0.62% 3.12% 3.12% 1.62%
Dividend Per Share
$0.02
39 $0.0240 $0.0242 $0.0250 $0.0257 $1.4229
Required Rate of Return 3.46% 3.46% 3.46% 3.46% 3.46% 3.46%
Discount Factor 1
0.966578
96
0.9342748
77
0.9030504
34
0.8728695
45
0.87286954
5
Discounted Dividend per
Share
$0.02
39 $0.0232 $0.0226 $0.0225 $0.0225 $1.2420
Intrinsic Value $1.36
The dividend discount model has been utilized and the valuation process of the share that
has been acquired reveal the fact that the intrinsic value of the share is $1.36. This is far greater
than the market value of the share, which is $0.39. This means that the shares have been
undervalued and the utilization of the Dividend Discount model will result in an increased value
of the shares.
Sensitivity Analysis
Sensitivity Analysis- Required Rate of Return
against Growth
Dividend Growth Rate
Required Rate of
Return
$1.3
6
0.400
%
0.70
%
1.00
% 1.30%
1.60
%
1.90
%
2.20
%
2.50
%
2.80
%
2.96 $1.72 $2.00 $3.3 - - - - - -

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% 6 5 66
$39.8
49
$2.1
39
$0.9
71
$0.5
84
$0.3
98
$0.2
92
3.06
%
-
$0.28
1
-
$0.27
5
-
$0.2
60
-
$0.24
0
-
$0.2
18
-
$0.1
94
-
$0.1
72
-
$0.1
51
-
$0.1
33
3.16
%
-
$0.13
1
-
$0.13
0
-
$0.1
27
-
$0.12
2
-
$0.1
16
-
$0.1
09
-
$0.1
02
-
$0.0
94
-
$0.0
87
3.26
%
-
$0.08
6
-
$0.08
6
-
$0.0
84
-
$0.08
2
-
$0.0
80
-
$0.0
76
-
$0.0
73
-
$0.0
69
-
$0.0
65
3.36
%
-
$0.06
5
-
$0.06
5
-
$0.0
64
-
$0.06
3
-
$0.0
61
-
$0.0
59
-
$0.0
57
-
$0.0
55
-
$0.0
52
3.46
%
-
$0.05
2
-
$0.05
2
-
$0.0
52
-
$0.05
1
-
$0.0
50
-
$0.0
49
-
$0.0
47
-
$0.0
46
-
$0.0
44
3.56
%
-
$0.04
4
-
$0.04
4
-
$0.0
44
-
$0.04
3
-
$0.0
43
-
$0.0
42
-
$0.0
41
-
$0.0
40
-
$0.0
38
3.66
%
-
$0.03
9
-
$0.03
8
-
$0.0
38
-
$0.03
8
-
$0.0
37
-
$0.0
37
-
$0.0
36
-
$0.0
35
-
$0.0
34
3.76
%
-
$0.03
4
-
$0.03
4
-
$0.0
34
-
$0.03
4
-
$0.0
33
-
$0.0
33
-
$0.0
32
-
$0.0
32
-
$0.0
31
The sensitivity analysis that has been conducted reveal the fact that in order to obtain the
highest value of the share a dividend growth rate of 1% should be chosen along with 2.96%
required rate of return.
Free Cash Flow to Equity Model
The Free Cash Flow to Equity Model refers to that particular model that measures the
amount of cash that is available to the equity shareholders of a company.post the time when the
expenses, reinvestment and debt in regards to the organization has been paid (Nobanee and
Abraham 2017). The particular formula for determining the value of the shares with the Free
Cash Flow to Equity Model is as follows:
Free Cash Flow to Equity Model = Net income – Net capital expenditure – net operating
capital change + new debt – debt repayment

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FCFE Valuation:
Current Forecast
FY Ending 2017 2018 2019 2020 2021 2022 Onwards
Time Period 0 1 2 3 4 5
FCFE Growth Rate 0.75% 1.00% 1.00% 1.30% 1.30% 0.75%
FCFE per Share $0.1520 $0.1535 $0.1550 $0.1570 $0.1591 $4.3230
Required Rate of Return 3.46% 3.46% 3.46% 5.96% 5.96% 4.46%
Discount Factor 1 0.967 0.934 0.841 0.793 0.804
Discounted FCFE/Share $0.15 $0.15 $0.14 $0.13 $0.13 $3.48
Intrinsic Value $4.18
The Free Cash Flow to Equity Model has been utilized and the valuation process of the
share that has been acquired reveals the fact that the intrinsic value of the share is $4.18. This is
far greater than the market value of the share, which is $0.39. This means that the shares have
been undervalued and the utilization of the Free Cash Flow to Equity model will result in an
increased value of the shares. Here, it must be noted that this particular valuation model assumes
that the growth rate will be 0.75% from 2022 onwards.
Sensitivity Analysis
Sensitivity Analysis- Required Rate of Return
against Growth
Growth
Required Rate of
Return
$4.1
8
0.500
0%
0.80
%
1.10
%
1.40
%
1.70
%
2.00
% 2.30%
2.60
%
2.90
%
2.96
%
$4.47
7
$4.54
3
$5.0
61
$6.4
24
$10.6
01
$74.3
31
-
$11.4
83
-
$4.8
20
-
$2.8
74
3.06
%
-
$2.79
9
-
$2.77
3
-
$2.6
08
-
$2.3
48
-
$2.04
8
-
$1.75
4
-
$1.48
8
-
$1.2
60
-
$1.0
68
3.16
%
-
$1.06
8
-
$1.06
4
-
$1.0
38
-
$0.9
94
-
$0.93
6
-
$0.86
9
-
$0.79
8
-
$0.7
27
-
$0.6
59
3.26
%
-
$0.66
3
-
$0.66
2
-
$0.6
52
-
$0.6
34
-
$0.61
0
-
$0.58
1
-
$0.54
9
-
$0.5
15
-
$0.4
80
3.36
%
-
$0.48
4
-
$0.48
3
-
$0.4
78
-
$0.4
69
-
$0.45
6
-
$0.44
0
-
$0.42
2
-
$0.4
02
-
$0.3
81
3.46 - - - - - - - - -

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%
$0.38
3
$0.38
3
$0.3
80
$0.3
74
$0.36
6
$0.35
6
$0.34
4
$0.3
32
$0.3
18
3.56
%
-
$0.31
8
-
$0.31
8
-
$0.3
16
-
$0.3
12
-
$0.30
7
-
$0.30
0
-
$0.29
2
-
$0.2
83
-
$0.2
74
3.66
%
-
$0.27
1
-
$0.27
1
-
$0.2
70
-
$0.2
67
-
$0.26
3
-
$0.25
8
-
$0.25
2
-
$0.2
46
-
$0.2
39
3.76
%
-
$0.23
3
-
$0.23
3
-
$0.2
32
-
$0.2
30
-
$0.22
7
-
$0.22
3
-
$0.21
9
-
$0.2
14
-
$0.2
09
The sensitivity analysis that has been conducted reveal the fact that in order to obtain the
highest value of the share a dividend growth rate of 2% should be chosen along with 2.96%
required rate of return.

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References
Lazzati, N. and Menichini, A.A., 2015. A dynamic approach to the dividend discount model.
Review of Pacific Basin Financial Markets and Policies, 18(03), p.1550018.
Nobanee, H. and Abraham, J., 2017. The Impact of Free Cash Flow, Equity Concentration and
Agency Costs on Firm's Profitability.