In-Charge is apublicly listed firm that provides technology allowing customers tomonitor their credit and debit card use, set spending limits andactivate and de-activate cards through apps on mobile devices. Thecompany recently struck deals with key payment processing companiesto adopt this technology in order to prevent fraud. In-Charge isentering a fast growth phase, which is expected to last for 5years. The following table contains reported income statementinformation for the recent year 2018 (all numbers are in$1,000s):
Year | 2018 | |
Revenues | 4,500 | |
Operating Costs (incl. Depreciation.) | 2,250 | |
EBIT | 2,250 | |
Interest expense | 2,025 | |
EBT | 225 | |
Taxes | 90 | |
Net Income | 135 | |
Detailed projections (in $1,000s) forthe years 2019-2023 are given below:
- Expected growth in revenues is 100% per year.
- Operating profit (EBIT) equals 50% of revenues in each of theyears 2019-2023.
- The increase in net working capital equals 25% of revenues ineach of the years 2019-2023.
- Gross investments in fixed assets equal $1,200 in each of theyears 2019-2023.
- The amount of depreciation is equal to $700 in each of theyears 2019-2023.
In-Charge currentlyhas 2 million shares outstanding and has a debt ratio(D/V) of 50% in market value terms. The firm hasa BBB bond rating and its equity beta equals 1.90. The interestrate on T-bonds equals 2.5%, the expected yield on BBB-rated bondsis 4% and the market risk premium is 5%. Finally, you can assumethat all cash flows will be realized at the end of the year andthat the firm is subject to a 40% marginal corporate tax rate. Withthis information answer the following four questions.
- Determine the relevant Free Cash Flows for a valuation of thefirm for the years 2019-2023 (in
$1,000s). Show your calculations.
- Calculate the weighted average cost of capital for In-Charge.Show all your calculations.
- Determine In-Charge’s business risk (or asset beta). Show allyour calculations.
- Now suppose that In-Charge wants to immediately change itsleverage to 25% with a corresponding cost of debt of 3%. If weassume that In-Charge maintains a constant growth rate of 2% after2023, what is In-Charge’s share price?
