Question

You are valuing a company that is projected to generate a free cash flow of $10 million next year, growing at a stable 3.0% rate in perpetuity thereafter. The company has $22 million of debt and $8.5 million of cash. Cost of capital is 10.0%. There are 50 million shares outstanding. How much is each share worth according to your valuation analysis?

1.

$2.41

2.

$2.73

3.

$2.23

4.

$2.01

5.

$2.59

Answer 1

This is a typical question of Equity Valuation where the company cash flows grow at a perpetual rate of 3%

We know that the formula for present value of perpetual growth of cash flows = D1/(r-g)

where D1 = Cash Flow at the end of year 1 = $ 10 million

r = Cost of Capital = 10% = 0.1

g = perpetual growth of cash flows

The present value of Cash Flows = D1/(r-g)

= 10/(0.1-0.03)

=10/0.07

= $ 142.8571428571 million

= $ 142.86 million

To find the equity value we need to remove the net debt from cash flows

Net Debt = Debt - Cash

= 22 - 8.5

= $ 13.5 million

Now net cash flows = Cash Flows - Net Debt

= 142.86 - 13.5

= $ 129.36 million

Now per value share = Present Value of Cash Flow / No of Outstanding Shares

= 129.36 / 50 (Both values are in millions so the zeros are ignored)

= 2.5872

= 2.59