Question

P7-14 Common stock value Variable growth Personal Finance Problem Home Place​ Hotels, Inc., is entering a​ 3-year remodeling and expansion project. The construction will have a limiting effect on earnings during that​ time, but when it is​ complete, it should allow the company to enjoy much improved growth in earnings and dividends. Last​ year, the company paid a dividend of ​$4.30. It expects zero growth in the next year. In years 2 and​ 3, 5​% growth is​ expected, and in year​ 4, 17​% growth. In year 5 and​ thereafter, growth should be a constant 9​% per year. What is the maximum price per share that an investor who requires a return of 15​% should pay for Home Place Hotels common​ stock?

P7-17 Free cash flow valuation Nabor Industries is considering going public but is unsure of a fair offering price for the company. Before hiring an investment banker to assist in making the public​ offering, managers at Nabor have decided to make their own estimate of the​ firm's common stock value. The​ firm's CFO has gathered data for performing the valuation using the free cash flow valuation model. The​ firm's weighted average cost of capital is 15%​, and it has $1,670,000 of debt at market value and $330,000 of preferred stock in terms of market value. The estimated free cash flows over the next 5​ years, 2020 through 2024​,

are given in the​ table,

Beyond 2024 to​ infinity, the firm expects its free cash flow to grow by 4% annually.

a.  Estimate the value of Nabor​ Industries' entire company by using the free cash flow valuation model.

b.  Use your finding in part a​, along with the data provided​ above, to find Nabor​ Industries' common stock value.

c.  If the firm plans to issue 200,000 shares of common​ stock

Answer 1

P7-14

D0 = $4.3

D1= D0*(1+0%) = $4.3

D2 = D1* 1.05 = $4.515

D3= D2*1.05 = $4.74075

D4 = D3*1.17 = $5.546678

D5= D4*1.09 = $6.045878

As constant growth starts in year 5 onwards

Horizon value at the end of 5 years = H5= D6/(r-g) = D5*(1+g)/(r-g) = 6.045878*1.09/(0.15-0.09) = $109.8335

Price per share = D1/1.15+D2/1.15^2+...+D5/1.15^5+H5/1.15^5

=4.3/1.15+4.515/1.15^2+4.74075/1.15^3+5.546678/1.15^4+6.045878/1.15^5+109.8335/1.15^5

= $71.054

So, maximum price that the Investor should pay is $71.05