Question

River enterprise has $493 million in debt and 17 million shares of equity outstanding. its excess cash reserves are $15 million. they are expected to generate $204 million in free cash flows next year with a growth rate of 2% per year in perpetuity. River enterprises cost of equity capital is 11%. after analyzing the company, you believe that the growth rate should be 3% instead of 2%. how much higher (in dollars) would the price per share be if you are right?

A) if the growth rate is 2% the price per share is ? (round to the nearest cent)

B) if the growth rate is 3% the price per share is?

Answer 1

a) Free Cash Flow in year 1 =204
at growth =2%
Value of Firm =Free Cash flow in Year 1/(Cost of equity capital-growth) =204/(11%-2%) =2266.67
Market Value of Share =(Value of Firm -Debt-Excess Cash Reserves)/Number of Shares =(2266.67-493-15)/17 =103.45

b) at growth =3%
Value of Firm =Free Cash flow in Year 1/(Cost of equity capital-growth) =204/(11%-3%) =2550
Market Value of Share =(Value of Firm -Debt-Excess Cash Reserves)/Number of Shares =(2550-493-15)/17 =120.12


Amount of increase in value =120.12-103.45 =16.67