Growth Rate of Fcfe

Let’s move on to the valuation part of our project. We have two models for the valuation. The first one is the discounted free cash flow to equity valuation model. In this model, we used a two-stage approach. That is, the growth rate of FCFE in the first stage had positive correlation with the growth rate of sales, while the growth rate of FCFE in the second stage tied to the growth rate of GDP in Hong Kong.

From this table, you can clearly notice that the sales figures appear to be an upward trend from 2010-2014. Therefore, the 5-year average growth rate of 12.74% was selected to predict future growth trend.

The following table shows the data retrieved from the financial statements. The five-year average figures were also calculated. You can notice that both of the net investment in working capital and debt financing appear to be negative. And this can surely be explained. Negative investment indicated that the company were continuously reducing its working capital in the recent years. You can also notice that the company was holding a great amount of cash and showed an upward trend, while short term debt remained at a constant level during the past few years. It shows that the company had strong confidence to retain its short-term financial health. Therefore, the company had reduced its non-cash investment in working capital. Next, the company had retired most of its short-term borrowings and long-term borrowings, which makes the change in debt financing to be negative.

The future cash flows were discounted using the CAPM. And the calculations are shown in this table. The following chart shows the growth rate of sales linked to growth rate of GDP in Hong Kong. According to the 10-year average GDP growth rate, we assumed that the growth rate of sales for the company to remain at 4% perpetually.

This table shows the valuation process with assumptions listed in the bottom. And at the end, we get the 1-year target price of HKD $52.05.

After that, we run the sensitivity test to check if the target price was sensitive to the inputs. As you can see here, the result was most sensitive to the change in equity risk premium and sales growth rate and least sensitive to the change in sales growth rate for the first 5 years. Therefore, we should be cautious about the equity risk premium and sales growth rate in our valuation.