Question

​Covan, Inc. is expected to have the following free cash​ flow: Year 1 2 3 4...

​Covan, Inc. is expected to have the following free cash​ flow:

Year

1

2

3

4

•••

FCF

11

13

14

15

Grow by

3%

per year

a. Covan has 8 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?

Homework Answers

Answer #1
Requirememt a
Value of the firm (V)
= (11/1.13)+(13/(1.13)^2)+(14/(1.13)^3)+(15/(1.13)^4)+ (((15 x1.03)/((0.13-0.03) x(1.13^4))
=$ 133.58
Share price = (V+cash -Debt)/Shares outstanding
= ($133.58 + $4 -0)/ 8 = $17.20
Requirememt b
Value of the firm (V) at beginning of year 2
=(13/(1.13))+(14/(1.13)^2)+(15/(1.13)^3)+ (((15 x1.03)/((0.13-0.03) x(1.13^3))
'= $ 134.94
Expected Share price = (V+cash -Debt)/Shares outstanding
= ($139.94 + $4 -0)/ 8 = $17.99
Requirememt c
Expected return = (17.99-17.20)/17.20
= 0.0462 or 4.62%
Note: Assumed free cash flow are in millions
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