Question

Q1. First Innovators, Inc. (FII) is presently enjoying relatively high growth because its latest new product is years ahead of its competition. Management expects earnings and dividends to grow at a rate of 40% for the next 4 years, after which its new product’s competition will increase and reduce the growth rate in earnings and dividends to 2%, i.e., g = 2%. The company’s last dividend, D0, was $2.75. FII’s beta is 1.50, the market risk premium is 6.75%, and the risk-free rate is 3.50%. What is the intrinsic value of FII’s common stock?

Q2. Suppose Yon Sun Corporation's free cash flow during the just-ended    (t = 0) year was $150 million, and FCF is expected to grow at a constant rate of 4% in the future. If the weighted average cost of capital is 15%, what is the firm's value of operations, in millions?

Q3. Zhdanov, Inc. forecasts that its free cash flow in the coming year, i.e., at t = 1, will be -$15 million (negative), but its FCF at t = 2 will be $30 million. After Year 2, FCF is expected to grow at a constant rate of 3% forever. If the weighted average cost of capital is 19%, what is the firm's value of operations, in millions?  

Answer 1

Answer to Question 1:

Required return, rs = Risk-free rate + Beta * Market risk premium
Required return, rs = 3.50% + 1.50 * 6.75%
Required return, rs = 13.625%

Last dividend, D0 = $2.75

Growth rate for next 4 years is 40% and a constant growth rate (g) of 2% thereafter.

D1 = $2.7500 * 1.40 = $3.8500
D2 = $3.8500 * 1.40 = $5.3900
D3 = $5.3900 * 1.40 = $7.5460
D4 = $7.5460 * 1.40 = $10.5644
D5 = $10.5644 * 1.02 = $10.7757

P4 = D5 / (rs - g)
P4 = $10.7757 / (0.13625 - 0.02)
P4 = $92.6942

P0 = $3.85/1.13625 + $5.39/1.13625^2 + $7.546/1.13625^3 + $10.5644/1.13625^4 + $92.6942/1.13625^4
P0 = $74.66

So, current stock price is $74.66