Question

​Covan, Inc. is expected to have the following free cash​ flow: (Year) 1 2 3 4 (FCF)12 14 15 16 Grow by 4 % per year

a. Covan has 7 million shares​ outstanding, ​$4 million in excess​ cash, and it has no debt. If its cost of capital is 13 %​, what should be its stock​ price?

b. Covan adds its FCF to​ cash, and has no plans to add debt. If you plan to sell Covan at the beginning of year​ 2, what is its expected​ price?

c. Assume you bought Covan stock at the beginning of year 1. What is your expected return from holding Covan stock until year​ 2?

Your expected return from holding Covan stock until the beginning of year 2 is ___​%

Answer 1

a)Stock price=(present value of free cash flow+cash -debt)/shares outstanding
present value of free cash flow=(12/((1+13%)^1))+(14/((1+13%)^2))+(15/((1+13%)^3))+(16/((1+13%)^4))+(16*(1+4%)/(13%-4%))/((1+13%)^4))
=155.19
Stock price=(155.19+4-0)/7=22.74
b)Here we find the stock price at end of year 1
=(14/((1+13%)^1))+(15/((1+13%)^2))+(16/((1+13%)^3))+(16*(1+4%)/(13%-4%))/((1+13%)^3))
=163.36
Stock price=(163.36+4-0)/7=23.34
c)return=(end-beg)/beg
=(23.24-22.74)/22.74
=2.20%