Question

1. Blackbriar’s most recent free cash flow to the firm (FCFF) is $5,000,000. The company’s target debt-to-equity ratio is 0.25. The company has 2 million shares of common stock outstanding and the market value of the firm’s debt is $10 million. The firm’s tax rate is 40%, the cost of equity is 10%, the firm’s pre-tax cost of debt is 8%, and the expected long-term growth rate in FCFF is 5%. Estimate the equity value per share using a single-stage free cash flow to the firm model.

Answer 1

Given about Blackbriar,

Cost of equity Ke = 10%

pre-tax cost of debt Kd = 8%

Tax rate t = 40%

D/E ratio = 0.25

So weight of debt Wd = 0.25/1.25 = 0.20

weight if equity We = 1-Wd = 1-0.2 = 0.8

So, weighted average cost of capital of firm, Kc = Wd*Kd*(1-t) + We*Ke = 0.2*8*(1-0.4) + 10*0.8 = 8.96%

recent free cash flows FCFF0 = $5000000

growth rate = 5% perpetual,

So, enterprise value using constant growth model is

So, EV0 = FCFF0*(1+g)/(Kc - g)

EV0 = 5000000*1.05/(0.0896-0.05) = $132575757.58 or 132.58 million

Value of equity is calculated as:

Value of equity = Enterprise value - Debt + cash = 132.58 - 10 + 0 = $122.58 million

Thus market value of equity = $122.58

So stock price per share = Market value of equity/number of shares = 122.58/2 = $61.29 per share

So, company stock price today = $61.29 per share.