Question 4 – Two-Stage FCFE Model: An Extended Application

Dionex Corporation, a leader in the development and manufacture of ion chromography systems (used to identify contaminants in electronic devices), reported earnings per share of $2.02 in 1993, and paid no dividends. These earnings are expected to grow 14% a year for five years (1994 to 1998) and 7% a year after that. The firm reported depreciation of $2 million in 1993 and capital spending of $4.20 million, and had 7 million shares outstanding. The working capital is expected to remain at 50% of revenues, which were $106 million in 1993, and are expected to grow 6% a year from 1994 to 1998 and 4% a year after that. The firm is expected to finance 10% of its capital expenditures and working capital needs with debt. Dionex had a beta of 1.20 in 1993, and this beta is expected to drop to 1.10 after 1998. (The treasury bond rate is 7%.)

A. Estimate the expected free cash flow to equity from 1994 to 1998, assuming that capital expenditures and depreciation grow at the same rate as earnings.

B. Estimate the terminal price per share (at the end of 1998). Stable firms in this industry have capital expenditures which are 150% of depreciation, and maintain working capital at 25% of revenues.

C. Estimate the value per share today, based upon the FCFE model.