Two-Stage FCFE Discount Model

Two-Stage FCFE Discount Model

This model is designed to value the equity in a firm, with two stages of growth, an
period of higher growth and a subsequent period of stable growth.

Assumptions

1. The firm is expected to grow at a higher growth rate in the first period.

2. The growth rate will drop at the end of the first period to the stable growth rate.

3. The free cashflow to equity is the correct measure of expected cashflows to stockholders.

The user has to define the following inputs:

1. Length of high growth period

2. Expected growth rate in earnings during the high growth period.

3. Capital Spending, Depreciation and Working Capital needs during the high growth period.

4. Expected growth rate in earnings during the stable growth period.

5. Inputs for the cost of equity.

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 Two-Stage FCFE Discount Model

Inputs to the model

Current Earnings per share = $4.00 (in currency)

Current Dividends per share = $0.25 (in currency)

Current Capital Spending/sh = $3.70 (in currency)

Current Depreciation / share = $1.70 (in currency)

Current Revenues/ share = $20.00

Working Capital/ share = $8.00 (in currency)

Chg. Working Capital/share = $1.00

Enter length of extraordinary growth period = 5 (in years)

Do you want to enter cost of equity directly? No (Yes or No)

If yes, enter the cost of equity = (in percent)

If no, enter the inputs to the cost of equity

Beta of the stock = 1.3

Riskfree rate= 7.00% (in percent)

Risk Premium= 5.50% (in percent)

Earnings Inputs

Do you want to use the historical growth rate? Yes (Yes or No)

If yes, enter EPS from five years ago = $0.49 (in currency)

Do you have an outside estimate of growth ? Yes (Yes or No)

If yes, enter the estimated growth: 19.00% (in percent)

Do you want to calculate the growth rate from fundamentals? Yes

If yes, enter the following inputs:

Net Income Currently = $1,077.00 (in currency)

Interest Expense Currently = $53.85 Last year (in currency)

Book Value of Debt = $600.00 $550.00 (in currency)

Book Value of Equity = $5,445.00 $5,130.00 (in currency)

Tax Rate on Income= 36.00% (in percent)

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 Two-Stage FCFE Discount Model

The following will be the inputs to the fundamental growth formulation:

ROC = 19.57% D/E = 11.02% (in percent)

Retention = 93.75% Interest Rate= 8.98% (in percent)

Do you want to change any of these inputs for the high growth period? No

If yes, specify the values for these inputs (Please enter all variables)

ROC = 19.57% D/E = 11.02% (in percent)

Retention = 93.75% Interest Rate= 8.98% (in percent)

Specify weights to be assigned to each of these growth rates:

Historical Growth Rate = 10.00% (in percent)

Outside Prediction of Growth = 40.00% (in percent)

Fundamental Estimate of Growth = 50.00% (in percent)

Enter growth rate in stable growth period? 6.00% (in percent)

Beta

Will the beta to change in the stable period? Yes (Yes or No)

If yes, enter the beta for stable period = 1.1

Capital Spending, Depreciation & Working Capital

Do you want all these items to grow at the same rate as earnings ? No

If not, enter the growth rates for each of the following items:

Capital Spending Depreciation Revenues

High Growth 20% 20% 18% (in percent)

Stable Growth Do not enter Do not enter 6% (in percent)

Do you want to keep the current fraction of working capital to revenues? Yes

Specify working capital as a percent of revenues: 40% (in percent)

Do you want to use the current debt ratio as your desired mix? Yes

If no, enter the following inputs for financing mix,

Desired debt financing proportion - Capital Spending (in percent)

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 Two-Stage FCFE Discount Model

Desired debt financing proportion - Working Capital (in percent)

Capital spending and Depreciation during Stable Growth Aswath Damodaran:

If you are going to assume
Is capital spending to be offset by depreciation in stable period? No Aswath
perpetualDamodaran:
growth, you shou
Yes or No.
answer no Ifhere
yes,and
enter the s
make
Do you want to compute your reinvestment rate from fundamentals? Yes return onexequity that than
your fi
that cap is higher
will have in perpetuity
depreciation belo
in your termin
Return on equity in stable growth period 12%
no,
year.enter cap ex as a perce
If no, enter capital expenditures as % of depreciation in stable growth 150% depreciatiion.

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 If you are going to assume
Aswath
perpetualDamodaran:
growth, you shou
Yes or No.
answer no Ifhere
yes,and
enter the s
make
return
that caponexequity that than
is higher your fi
Two-Stage FCFE Discount Model will have in perpetuity
depreciation belo
in your termin
no,
year.enter cap ex as a perce
depreciatiion.

Output from the program

Cost of Equity = 14.15%

Proportion of Debt: Capital Spending (DR)= 9.93%

Proportion of Debt: Working Capital (DR)= 9.93%

Current Earnings per share= $4.00

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 Two-Stage FCFE Discount Model

(Capital Spending - Depreciation)*(1-DR) $1.80

Change in Working Capital * (1-DR) $0.90

Current FCFE $1.30

Growth Rate in Earnings per share

Growth Rate Weight

Historical Growth = 52.19% 10.00%

Outside Estimates = 19.00% 40.00%

Fundamental Growth = 19.77% 50.00%

Weighted Average 22.71%

Growth Rate in capital spending, depreciation and working capital

High Growth Stable Growth

Growth rate in capital spending = 20.00% Do not enter

Growth rate in depreciation = 20.00% Do not enter

Growth rate in revenues = 18.00% 6.00%

Working Capital as percent of revenues = 40.00% (in percent)

The FCFE for the high growth phase are shown below (upto 6 years)

1 2 3

Earnings $4.91 $6.02 $7.39

- (CapEx-Depreciation)*(1-DR) $2.16 $2.59 $3.11

-Chg. Working Capital*(1-DR) $1.30 $1.53 $1.81

Free Cashflow to Equity $1.45 $1.90 $2.47

Present Value $1.27 $1.46 $1.66

Growth Rate in Stable Phase = 6.00%

FCFE in Stable Phase = $5.90

Cost of Equity in Stable Phase = 13.05%

Price at the end of growth phase = $83.65

Present Value of FCFE in high growth phase = $8.40

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 Two-Stage FCFE Discount Model

Present Value of Terminal Price = $43.16

Value of the stock = $51.56

Estimating the value of growth

Value of assets in place = $9.94

Value of stable growth = $9.57

Value of extraordinary growth = $32.05

Value of the stock = $51.56

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 Two-Stage FCFE Discount Model

ount Model

, with two stages of growth, an initial

nt period of stable growth.

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 Two-Stage FCFE Discount Model

(Yes or No)

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 Two-Stage FCFE Discount Model

(Yes or No)

(Yes or No)

(Yes or No)

(Yes or No)

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 Two-Stage FCFE Discount Model

Aswath Damodaran:
If you are going to assume
Aswath(Yes or No)
perpetualDamodaran:
growth, you should
Yes or No.
answer no Ifhere
yes,and
enter the sure
make
return
that caponexequity that than
is higher your firm
will have in perpetuity
depreciation below. If
in your terminal
no,
year.enter cap ex as a percent of
depreciatiion.
(in percent)

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 If you are going to assume
Aswath
perpetualDamodaran:
growth, you should
Yes or No.
answer no Ifhere
yes,and
enter the sure
make
return
that caponexequity that than
is higher your firm
will have in perpetuity
depreciation below. If
in your terminal Two-Stage FCFE Discount Model
no,
year.enter cap ex as a percent of
depreciatiion.

ogram

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 Two-Stage FCFE Discount Model

4 5

$9.07 $11.13

$3.74 $4.48

$2.13 $2.51

$3.20 $4.13

$1.89 $2.13

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 Two-Stage FCFE Discount Model

Terminal Year

$11.79

$4.91

$0.99

$5.90

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