Question

Hadley Inc. forecasts the year-end free cash flows (in millions) shown below. Year 1 2 3 4 5 FCF -$22.95 $37.9 $43 $51.2 $55.2 The weighted average cost of capital is 12%, and the FCFs are expected to continue growing at a 4% rate after Year 5. The firm has $26 million of market-value debt, but it has no preferred stock or any other outstanding claims. There are 18 million shares outstanding. What is the value of the stock price today (Year 0)? Round your answer to the nearest cent. Do not round intermediate calculations.

$ per share

According to the valuation models developed in this chapter, the value that an investor assigns to a share of stock is dependent on the length of time the investor plans to hold the stock.

The statement above is

Answer 1

Answer a.

FCF1 = -$22.95
FCF2 = $37.90
FCF3 = $43.00
FCF4 = $51.20
FCF5 = $55.20

Growth Rate = 4.00%
WACC = 12.00%

FCF6 = FCF5 * (1 + Growth Rate)
FCF6 = $55.20 * 1.04
FCF6 = $57.408

Horizon Value = FCF6 / (WACC - Growth Rate)
Horizon Value = $57.408 / (0.12 - 0.04)
Horizon Value = $57.408 / 0.08
Horizon Value = $717.60

Value of Firm = -$22.95/1.12 + $37.90/1.12^2 + $43.00/1.12^3 + $51.20/1.12^4 + $55.20/1.12^5 + $717.60/1.12^5
Value of Firm = $511.375

Value of Equity = Value of Firm - Value of Debt
Value of Equity = $511.375 - $26.000
Value of Equity = $485.375

Stock Price = Value of Equity / Shares Outstanding
Stock Price = $485.375 / 18
Stock Price = $26.97

Answer b.

This statement is false. The value that an investor assigns to a share of stock is independent on the length of time the investor plans to hold the stock.