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Case for Discussion

Having been established a decade back, ABC Ltd has overcome its initial, teething problems and is now well on course to a period of fast-paced growth. The year gone by saw revenues of ₹10 billion, which establishes a firm basis for the future of the company. The company has, over the last few years, made the required investments and the time has come to reap the rewards of those investments. The cash flow from operations are likely to be strong, without any concomitant need for further funding of long-term assets. In other words, huge free cash flows are expected.
You are running a large fund, planning to invest in ABC Ltd. What, according to you, is the value of ABC Ltd? Assume the following:
Today is the 1 January 2019. The calendar year 2018 had the following figures:

1. Sales value is of ₹10 billion. Number of units sold is 1,000,000, each priced at ₹10,000.

2. Raw material costs ₹5,500 per unit.

3. Operating expenses are ₹1.70 billion.

4. Depreciation is ₹0.7 billion.

5. Tax rate is 30 per cent

There are two phases of high growth for the company. The initial phase of explosive growth lasts for four years, and during this period the sales grow at 30 per cent per annum. Raw material costs grow at 20 per cent per annum, operating expenses at 15 per cent annually and depreciation remains constant. There are no fresh investments required except of replacing the equipment depreciation.
After the initial phase of explosive growth, the next phase lasts for five years during which the growth continues to be high but does not match that in the previous phase.
Sales grow at 18 per cent annually, raw material costs by 12 per cent per annum and operating expenses by 10 per cent. To support sales at high levels, fresh investment is required at ₹10 billion before the second phase of growth. This investment will be depreciated over the next five years.
The working capital requirement is 25 per cent of the current year’s sales.
After the second phase of growth is over, the company settles down to normalcy to a new phase of maturity and the free cash flow generation increases constantly at 3 per cent per annum forever.
The company has issued 100 million shares at different prices to finance the investment at various times. The company’s operating leverage is quite high, leading to a high risk. The required rate of return (cost of capital) is, therefore, high at 18 per cent. Find the value of the company.


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