Question

# Question 7 You are valuing a company that generated free cash flow of \$10 million last...

Question 7

You are valuing a company that generated free cash flow of \$10 million last year, which is expected to grow at a stable 3.0% rate in perpetuity thereafter. The company has no debt and \$8 million in cash. The market risk premium is 8.4%, the risk-free rate is 2% and the firm’s beta is 1.4. There are 50 million shares outstanding. How much is each share worth according to your valuation analysis?

 1 \$2.75 2 \$2.02 3 \$2.07 4 \$2.67 5 \$2.31

The value is computed as shown below:

Required rate of return is computed as shown below:

= risk free rate + Beta x market risk premium

= 0.02 + 1.4 x 0.084

= 13.76% or 0.1376

The value of the firm is computed as follows:

= [ [ FCF last year (1 + growth rate) / [ (required rate of return - growth rate) ] ] + cash ] / Number of shares

= [ [ \$ 10 million x 1.03) / [ (0.1376 - 0.03) ] + \$ 8 million ] / 50 million shares

= \$ 103.7249071 / 50 million shares

= \$ 2.07 Approximately

So, the correct answer is option 3.

Feel free to ask in case of any query relating to this question