Question

1. PA Film Corporation’s last free cash flow was $1.55 million. The free cash flow growth rate is expected to be constant at 1.5% for 2 years, after which free cash flows are expected to grow at a rate of 8.0% forever. The firm's weighted average cost of capital (WACC) is 12.0%. It has $2 million in short-term debt and $14 million in debt and 1 million shares outstanding. What is the best estimate of the intrinsic stock price? a. $28.48 b. $26.16 c. $27.30 d. $29.70 e. $25.05

Answer 1

The price is computed as shown below:

= FCF in year 1 / (1 + WACC)¹ + FCF in year 1 / (1 + WACC)¹ + 1 / (1 + WACC)² x [ (FCF in year 2 x (1 + growth rate) / (WACC - growth rate) ]

= ($ 1.55 million x 1.015) / 1.12 + ($ 1.55 million x 1.015²) / 1.12² + 1 / 1.12² x [ ($ 1.55 million x 1.015² x 1.08) / (0.12 - 0.08) ]

= $ 1.57325 million / 1.12 + $ 1.59684875 million / 1.12² + $ 43.11491625 million / 1.12²

= $ 1.57325 million / 1.12 + $ 44.711765 million / 1.12²  

= $ 37.04863281 million

So, the value per share will be as follows:

= ($ 37.04863281 million + short term debt - debt) / Number of shares

= ($ 37.04863281 million + $ 2 million - $ 14 million) / 1 million

= $ 25.05 Approximately

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