Question

Flying Cow Aviation Inc.’s free cash flows (FCFs) are expected to grow at a constant long-term growth rate (gLgL) of 14% per year into the future. Next year, the company expects to generate a free cash flow of $8,000,000. The market value of Flying Cow’s outstanding debt and preferred stock is $51,428,571 and $28,571,429, respectively. Flying Cow has 6,750,000 shares of common stock outstanding, and its weighted average cost of capital (WACC) is 21%.

Given the preceding information, complete the adjacent table (rounding each value to the nearest whole dollar), and assuming that the firm has not had any nonoperating assets in its balance sheet.

Term	Value
Value of Operations	$___________
Value of Firm’s Common Equity	$___________
Value of Common Stock (per share)	$___________

Oops, a more careful review of Flying Cow’s balance sheet actually reports a $2,480,000 portfolio of marketable securities. How does this new information affect the intrinsic value of Flying Cow’s common equity (expressed on a per-share basis) assuming no other changes to the Flying Cow financial situation? Review the statements below and select those that accurately describe Flying Cow’s financial situation. Check all that apply.

1. The intrinsic value of Flying Cow’s common stock decreases with the inclusion of the company’s marketable securities portfolio into the analysis.

2. The intrinsic value of the company’s common stock isn’t affected by the new information.

3. The revised intrinsic value of Flying Cow’s common stock is $5.45 per share.

4. The greater the market value of the marketable securities portfolio, the smaller the company’s total intrinsic (entity) value.

Answer 1

Value of operations is equal to the present value of all future free cash flows

= 8,000,000/(21%-14%)

= $114,285,714.29

Value of Equity = Value of operations – Value of debt – Value of preferred stock

= 114,285,714.29 – 51,428,571 – 28,571,429

= $34,285,714.29

Value per share = Value of Equity/Number of shares

= 34,285,714.29/6,750,000

= $5.0794 per share

i.e. $5.08 per share

New value = 5.08 + 2,480,000/6,750,000

= $5.45 per share

i.e. Intrinsic value increases

Hence, the correct statements are

3. The revised intrinsic value of Flying Cow’s common stock is $5.45 per share.