Reference no: EM131938760
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 NewMarket, Inc. The planner says that NewMarket’s EBITDA of $1,580 million divided by the long-term government bond rate of 7 percent gives a total value of $22,571.4 million. With 318 million outstanding shares, NewMarket’s value per share found by using this method is $70.98. Shares of NewMarket currently trade for $36.50.
A) Provide your client with an alternative estimate of NewMarket’s value per share 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.
NewMarket’s beta is 1.3; the risk-free bond rate is 7 percent; 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.
NewMarket has 318 million shares outstanding.
B) Criticize the valuation approach that the aggressive financial planner used.