Question

Hanover Inc. is an all-equity firm with 35,000 shares of stock outstanding. The firm expects sales of $750,000 next year. Sales are expected to grow by 10 percent the following year and then level off to a constant 4 percent growth rate. Net cash flow varies in direct proportion to sales and is currently equal to 17 percent of sales. The required return for this firm is 14 percent. What is the estimated current value of one share of stock?

Answer 1

next year 1 sales = $ 750,000

Net cash flows of year 1 = $ 750,000 * 17% = $ 127,500

Net cash flows of year 2 = $ 127,500 * 1.10 = $ 140,250

From year 3, Net cash flows are grow 4% forever,so we calculate terminal value at end of year 2.

Net cash flows of year 3 = $ 140,250 * 1.04 = $ 145,860

Terminal cash flows at end of year 2 = $ 145,860 / (0.14- 0.04) = $ 1,458,600

Current value of firm = $ 127,500 / 1.14 + 140,250 / (1.14)² + 1,458,600 / (1.14)² = $ 1,342,105.263

Current share price = current value of firm /no of shares outstanding

= $ 1,342,105.263 / 35,000 shares

Current price of share = $ 38.346 per share.