FINE 7640
Valuation
Spring 2021

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FCFF Model
Using Tesla’s financial reports, we are forecasting the stock price at the beginning of year 2017.
[All the dollar values are in thousands]

Step 1. Estimate the Discount Rate.

a. Find the cost of equity using information in Excel “Stock Return”.
[Use the 10-year treasury rate in the CAPM. Assume a market risk premium of 5.5%]

a.2. Based on the regression, do you think this is a good estimate for the firm’s cost of equity?

b. Find the cost of debt using the information in Excel “Cost of Capital”

c. Find the cost of capital (WACC) using information in Excel “Cost of Capital”.
[Note: We shall adjust the market value of debt by the operating lease. You should solve step 2,
part a, before solving this part]

Step 2. Adjustment on accounting measures.

a. Find the Operating lease using information in Tesla’s 2016 annual report, then put all
information in Excel “Operating lease Converter”.

b. Find the R&D expense using information in Tesla 2016 annual report and Tesla 2013 annual
report over last 6 years, then put all information in Excel “R&D Converter”.

c. Our base year is 2016. Using the financial information, calculate the adjusted operating
income (EBIT) and operating margin (EBIT) in the base year. You should fill in your answers
in the Excel “valuation output”. Write down the formula to calculate the adjusted operating
income.

d. Calculate the invested capital in the base year. Write the formula to calculate the invested
capital. Should we include cash and marketable securities in the invested capital? Explain your
results.

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e. At the end of 2016, Tesla has carry-forward net operating loss (NOL) of \$4,340,000. How will
this NOL affect for Tesla’s future after-tax EBIT?

Step 3. Assumptions
We will use a 3-stage model with a ten-year extraordinary growth period. After year 10, assume
the remaining years with stable growth rate.

a. Which industries does Tesla belong to?

b. Since the firm has negative operating income, we need start our growth forecast from revenue.
Explain how one might estimate the revenue growth rate of Tesla in the extraordinary growth
period and in the stable growth period.

c. Assume a sales growth rate of 35% from year 1 to year 5, then from year 6, we assume the
sales growth will drop linearly to 2.23% in year 10. After year 10, the sales growth rate will
remain at 2.23%. Fill in the revenue growth rate in Excel “Valuation Output”.

d. We assume Tesla in year 10 will reach a target operating margin. Explain how to find the
target operating margin.

e. Assume the target operating margin is 12% in year 10. Assume the operating margin of Tesla
will move linearly toward the target operating margin. Fill in the operating margin from year 1 to
year 10.

f. We need to reinvest capital to sustain the sales growth rate. Explain how to find a target sales-
to-capital ratio.

g. Assume the target sales-to-capital ratio is 2.24. For Tesla, do you think this is a reasonable

Step 4. Cash flow forecast
a. Based on the above three steps, find the FCFF from year 1 to year 10.

b. The cost of capital we estimated in Step 1 should be the current cost of capital. As the firm
moves to the stable growth, the cost of capital will also change. Assume, from year 1 to year 5, a
cost of capital equal to the current cost of capital. From year 6 to year 10, assume the cost of
capital will linearly reduce to the stable cost of capital, with the stable cost of capital= Current
cost of capital -1%. Fill in the cost of capital in Excel “Valuation Output”.

c. Calculate the value of equity/share using all the information above. 