Question

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

Year	1	2	3	4	times•••
FCF	12	14	15	16	Grow by 4%per year

a. Covan has 88 million shares​ outstanding, $22 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?

a. Covan has 88 million shares​ outstanding, $22 million in excess​ cash, and it has no debt. If its cost of capital is 13%​, what should be its stock​ price?

The stock price should be​ $$??? (Round to the nearest​ cent.)

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?

If you plan to sell Covan at the beginning of year​ 2, its price should be ​$$$$??? (Round to the nearest​ cent.)

c. Assume you bought Covan stock at the beginning of year 1. What is your expected return from holding Covan stock until year​ 2? Your expected return from holding Covan stock until the beginning of year 2 is ?????%.(Round to one decimal​ place.)

Answer 1

a) Terminal Value in year 4 (TV) = FCF4 / (r - g) = 16 x (1 + 4%) / (13% - 2%) = $151.27 million

Value today = FCF1 / (1 + r) + FCF2 / (1 + r)^2 + FCF3 / (1 + r)^3 + (FCF4 + TV) / (1 + r)^4

= 12 / 1.13 + 14 / 1.13^2 + 15 / 1.13^3 + (16 + 151.27) / 1.13^4

= $134.57 million

Stock Price = (Value + Cash) / No. of shares = (134.57 + 22) / 88 = $1.78

b) Value 2 years later = 15 / 1.13 + (16 + 151.27) / 1.13^2 = $144.27 million

Stock Price = (144.27 + 22 + 12 + 14) / 88 = $2.18

c) Returns = 2.18 / 1.78 - 1 = 22.80%