Marshall Law firm expects to generate free-cash flows of $200,000 per year for the next five years. Beyond that time, free cash flows are expected to grow at a constant rate of 5 % per year forever. If the firm's weighted average cost of capital is 15 %, the market value of the firm's debt is $500,000, the market value of its preferred stock is $200,000 and the firm has a half million shares of common stock outstanding, what is the value of its common stock?
Please solution step by step
Cash flows after 6th year= CF* (1+g)= 200,000 *(1+0.05)= 210000
Terminal cash flow >= year 5= FCF/ (r-g) = 210000 / (0.15-0.05) = 2100,000
Discounting the terminal cash flow to present = 2100000/(1+0.15)^15 = 1044071.144
Present value cash flow for 1 to 5 years is 200000*PVIFA(15%,5 Years) = 200000*(3.352155098) = 670431.0196
Total PV= Present value cash flow for 1 to 5 years + terminal cash flow = 1044071.144+670431.0196 = 1714502.1636
Value of equity = (Total PV- Debt)/ Shares outstading = (1714502.1636- 500000 )/ 500000
Hence value of share = 2.4290043272
SImply VPS of Marshall Law firm = $2.43
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